Saturday, September 21, 2013
Friday, January 4, 2013
Sunday, October 14, 2012
Softbank Stock Looks Compelling
What would you say if I told you that you could buy Japan’s
best wireless telecom carrier (growing at 8%), coupled with the Google of
Japan, for only 3.3x EBITDA? Investment
grade rated with 40% ROE’s, the firm has tripled its EPS since 2008. Oh, and I would throw in an $11BB stake in
Alibaba for FREE, plus an option to buy 70% of Sprint shares for $6.25, which are
likely worth $10+ in 2 years.
This is the value proposition for Softbank today, ticker
9984 out of Tokyo, also with an ADR that trades under the ticker symbol SFTBY
in the US.
This week Sprint (S) and Softbank confirmed that talks were
in the works for Softbank to acquire a majority plus stake in Sprint. Reportedly management of the Japanese
conglomerate would like to pay less than $6.50 a share to acquire 70% of
Sprint. That math works out to around
$6.25 per Sprint share based on rumors of a ¥1TT deal (or $12.8BB). I’ll
get to the potential deal dynamics below.
Sprint stock unsurprisingly zoomed from $5.00 to roughly $5.75
per share, while Softbank surprisingly fell
17% in one day on the news! To put some numbers around that, Softbank shed
$7.1BB in market cap for a deal that is only $12.8BB in total invested
capital. Is Softbank really overpaying by
$7BB for Sprint shares? The market
thinks so. Sprint by the way gained
$2.2BB in market cap.
Put differently, the market suggests that Softbank is
overpaying by $3.54 a Sprint share, meaning if the deal goes through, you
effectively as a Softbank holder today are investing in Sprint at the bargain
price of only $2.71. (Math is $6.25
Sprint purchase price less $7.1BB lost market cap divided by 2BB shares of
Sprint they are buying).
Even factoring in a worst case scenario for Softbank which
entails buying Sprint at a full $6.50 a share, Softbank shares are a compelling
long based on a sum of the parts and FCF yield analysis. Much of the investment has to be considered
too in light of the firm’s CEO and founder, the brash and charismatic Masayoshi
Son.
Basics:
Softbank Description
Softbank is 21% owned by Son, who founded the firm in the
1980s to distribute Microsoft software in Japan. The firm evolved into a telecom and internet
conglomerate, with Softbank’s purchase of Vodafone Japan for $17BB his entrée
into the mobile space in Japan in 2006. Son
also smartly invested a 31.9% stake in the Alibaba Group in 2000, pushing its
now famous found Jack Ma to start Taobao to compete with a then well-established
Ebay which was making forays into China in 2002. This is a great history of Softbank.
Much has been made of Son’s willingness to make huge
acquisitions fueled by debt, and while that resonates to some wary long term
investors in Softbank, the Sprint deal actually is a good one despite that fact
that it is one that Softbank intends to borrow to finance. Not only that, but the company is only 0.8x
levered today (Debt/EBITDA), and would be only 1.76x levered under a fully debt
financed Sprint deal. That is still
within investment grade land. After the Vodafone
deal in 2007, total debt then was ¥2.4TT Yen, which at the time implied
Debt/EBITDA of 3.83x.
Here is a financial snapshot of Softbank:
One item of note here.
Capex will be much higher in FY 2013 (year ending March 2013) as
Softbank builds out en masse its 900MHz base stations. Post this, capex is expected to normalize at
¥450BB. FCF per share works out to ¥290
this fiscal year on a ¥2395 share price using the normalized capex figures.
Sprint Deal
It’s unclear exactly how a Sprint transaction will shake
out, as Softbank is reportedly attempting to buy 70% of Sprint stock by
tendering for existing shares, and also by putting in fresh capital in return
for new shares. I suspect that a tender
offer for $6.50 is in the cards, as well as a deal to invest a significant
amount of cash for newly issued Sprint shares at current prices. I think shareholders in Sprint perhaps are
missing out on the fact that Softbank does not want to outright buy
Sprint. In fact, reportedly a number of
large holders would turn down a deal for Sprint at $6.50.
That is fine with Son, who likes to take big stakes at
attractive valuations and let them ride.
In addition to Softbank’s Alibaba 32% stake, the firm also owns 42% of
Yahoo Japan, the dominate provider of search in Japan and in fact powered by
Google’s search technology. Yahoo Japan
shouldn’t scare investors here, they have 56% market share and have great brand
equity too. (In the 1990s, Son acquired
40% of Yahoo when it was still in the start up phase too, not a bad trade).
So, Softbank would tender for perhaps 1.0BB to 1.5BB of
Sprints 3BB shares for $6.50, taking what he can get and investing cash for
another 1BB share at say $6. That means
Sprint holders likely can sell 1/3 of your shares at $6.50, and keep the rest
which will likely trade at current levels give or take. (It’s hard to assume anything different, but
anything is of course possible).
So, at $5.75, while the upside to Sprint is decent over the
next 2 years, in the near term I can make 75c on 1/3 of my shares perhaps, but
then the other 2/3s will likely trade at current levels. That
gets me 25c of upside with a Softbank deal, but without a deal, downside of 75c
a share!
See my write-up on Sprint at $2.45 when I originally
purchased the name last December. I do
believe it’s ultimately an $8-10 stock in a couple of years, but the better
risk reward is in Softbank right now.
Softbank Valuation
First of all, owning big companies run by tough, smart,
competitive founders is usually a win.
Buying them at hugely discounted valuations is even better. What has Microsoft done without Bill
Gates? Oracle has been phenomenal under
the leadership of Larry Ellison. Son is
the Japanese version of these guys, working 19 hour days and growing up a poor
Korean immigrant in a socially rigid Japanese world. This is the kind of guy that bucks the
establishment and is keenly interested in growing shareholder value, a trait
surprisingly uncommon in Japanese society.
As for valuing Softbank, it’s pretty straightforward. Some notes: Yahoo sold half of its stake in
Alibaba at a $35BB valuation last May, and Dan Loeb’s reason for owning Yahoo
is based on the future of Alibaba (which looks quite solid and why they only
sold half), as well as Yahoo’s stake in Yahoo Japan. He should sell his Yahoo and buy Softbank
where he gets the Alibaba stake for free essentially.
Softbank’s consolidated subsidiaries include tons of businesses,
but generally can be broken down into its telecom businesses (mobile, fixed,
and broadband), and its internet culture businesses (Yahoo Japan). Then Softbank has dozens of unconsolidated
subsidiaries which are accounted for under the equity method (ie the financial
statements generally do not consolidate the cash, revenues, etc except under
one line on both the Income Statement and Balance Sheet).
The most important of the unconsolidated businesses are of
course Alibaba, but also Renren which trades on the NYSE, Ustream, Wireless
City Planning, and Zynga to name a few.
I have only given the firm credit for Alibaba and Renren (in Other Value
below), and consider the others free options. As a side note, the stake in Zynga is
undisclosed.
Note figures are in BB of Yen except per share amounts or
USD amounts where labeled. I also modeled
Sprint as a loser investment in my base case, dragging down the valuation by ¥232BB. That still offers upside of 63% for Softbank
holders.
For direct comparisons sake, I modeled a $9 Sprint scenario
in 2 years, which offers a double (up 105%) in the case of owning Softbank, and
upside of 56% for Sprint holders (9/5.75-1).
Arguably, you could own both, however.
But if a deal falls through, you make perhaps the 17% back from Softbank
immediately, or lose 13% in a Sprint investment immediately (5 / 5.75 – 1). Again, the risk reward is skewed given the
asymmetrical movements in the 2 equities post this news.
Finally, the biggest piece here is the telecom
multiple. Nippon (NTT) trades at 5.25x
EBITDA, and a 9.1% FCF yield. Slapping a
9.1% FCF yield on Softbank, and adding in the Alibaba stake would imply a ¥4000
per share value for Softbank, for upside of 67%.
As far as the downside case, I had to throw a 3x multiple on
the Telecom business (half the multiple of most wireless comps and unreasonably
low), and a 15% decline on the recently traded Alibaba Group value to get to a
down 9% case for Softbank stock. Seems
highly unlikely to me.
Other items:
-
Softbank has offered to acquire eAccess, a rival
in Japan, in a $2.2BB stock swap. The
terms of the deal include a provision that if Softbank shares drop by more than
the ¥3108 base price, then eAccess shareholders can receive more shares from
Softbank. The math is that if the
average price 10 trading days after October 1st is 15% below the
3108 base price, then the swap ratio gets recut in eAccess’ favor. However, with only 2 days left the stock
would have to fall impossibly low (below allowable circuit breaker rules on
individual stocks) for the deal terms to change. I also have not factored in any gains or synergies
from this deal, as Softbank stock rallied over 4% on news of this takeover.
-
Much speculation as to Softbank acquiring
Clearwire (CLWR) seems to have pushed that stock up dramatically too. I wrote up Clearwire as well when it was
around a buck, and at $2.32 I think the speculative fervor is a tad high. I’d scale back. Ultimately, I give it low odds that Softbank
would recapitalize the $4.4BB of Clearwire debt (and growing) needed to avoid a
restructuring, although this is pure speculation on my part.
-
Reuters reported late Friday that Softbank is in
talks to borrow ¥1.8TT Yen, which is much higher than the original ¥1.0TT
reported by the Wall Street Journal.
Perhaps they are looking to purchase more than 70% of Sprint, or perhaps
they are merely putting in place revolving debt capacity to fund the deal as
well as some refinancing of Sprint’s or Clearwire’s debt.
-
I haven’t factored in interest cost savings that
the investment grade rated Softbank brings to the table for Sprint (junk rated),
as well as purchasing synergies (for phones, iPhones, tower equipment, etc)
that seem likely as well.
-
Yen risk is real. The yen is currently quite strong and could
fall for a variety of reasons that any good macro analyst will tell you. Lots of smart guys have been short JGB’s
(Japanese Government Bonds) for years however waiting either the collapse in
the Yen or a hike in yields.
-
If a deal is reached, Softbank shares could stay
in the penalty box while Japanese investors grapple with the implications of a
seemingly non-synergistic international acquisition.
Conclusion
It’s hard to handicap the odds of this deal. Speculation of Softbank also acquiring
MetroPCS have reportedly been denied by those in the know. That is good, I am not sure it makes sense
for Softbank to go hog wild snapping up all the third tier mobile operators in
the US. In fact, Sprint’s board also kiboshed
the idea of a competitive bid for MetroPCS (which Deutsche Telecom is
acquiring).
In any case, Softbank is cheap under almost any scenario,
either one whereby they purchase Sprint or not.
I am sure Japanese investors do not see the value in buying the #3, money
losing wireless company in the US. Fears
of an eAccess stock ratio redo probably also contributed to the sell off in
Softbank.
In any case, while it may take a couple of years and some
bumps along the road, Softbank with or without Sprint is a compelling long, one
that could be a double with a little patience.
Good luck.
Monday, August 15, 2011
How to Invest in a Hedge Fund Via Greenlight RE, GLRE
I was up a lot last night thinking of the problems facing our markets. We face lots of macro risks, but at least now there appears to be some reward in select stocks I am buying.
Macro risks to keep in mind:
1) Economic concerns in the US, as slowing government spending and weak consumer spending might push the US into a recession next year. I think odds are better than 50% we'll double dip so to speak. Even if we don't double dip, GDP growth in the first half of this year was a meager 0.9%, and the trend is not your friend right now.
2) European banks, which hold so much European sovereign debt, that there actually could be a liquidity crisis in the next 3 months. With French bank BNP Paribas down 24% intraday last week, liquidity fears are clearly beginning to boil over. It was summer 2008 that stocks like MS, MER, GS, LEH were getting hit 10% - 20% per day. Eventually the Fed let Lehman go under, but then reversed course and bailed out the entire banking system via $800BB of TARP money. It didn't stop financials from collapsing and the equity markets to fall 37%. Today it's the European financial system. Leverage among these banks is as high as it was in 2007. It got very ugly in 2008 amidst the run on the banking system. I honestly expect that the odds of a European bank panic are close to 100%, I just don't know when. But it is out there.
3) China. Yes, China has been the savior to the world's economy since 2008. Pumping capital into infrastructure projects, lending money to consumers at an astronomical pace, loading up on commodities worldwide. But when 60% of your GDP is derived from fixed asset investments (ie infrastructure projects), there is massive downside risk to spending. Because FAI is not recurring in nature, eventually it has to revert to normalized levels. FAI growth was 67% in 2009, 33% in 2010, and 25% in the first half of 2011. I read that FAI growth accounted for 8% of their 8.7% growth in GDP last year. When will China simply reach a level of overcapacity and slow down? It's not consumer spending driving GDP in China, its the government.
Greenlight RE
So, looking for defensive stocks makes sense to me, but also one perhaps that has some upside if the market rallies. The one I recommend buying now is Greenlight RE, ticker GLRE. Greenlight is technically an insurance company. They underwrite a variety of property and casualty reinsurance, but the reality is that it's essentially an investment in a hedge fund, but one with daily liquidity despite that fact that NAV is published only quarterly.
So, why GLRE in this market?
First of all, GLRE is only 30% net long right now. That is, their portfolio is heavily hedged. If the market falls 20%, then GLRE's portfolio will fall far less than the market, perhaps only 5-6%. Second, you have to understand the track record of David Einhorn who manages the money for GLRE. Einhorn's hedge fund has racked up double digit returns in all but 3 years since 1996, when he launched Greenlight Capital. In 2004, he started Greenlight RE, patterned somewhat after Berkshire Hathaway. Essentially, he sells insurance policies and then invests the float in public equities. Through the insurance premiums he collects, he essentially gets free, long-dated capital, assuming you can at least run your insurance business at a 100% combined ratio. That is, without losses or at a breakeven level.
Boring Insurance Stuff
So, Einhorn raised $200mm back in 2005 via an IPO and established a vehicle that essentially invests in his hedge fund called DME Advisors. His firm writes reinsurance property & casualty policies, collects the premium and invests it hedge fund style. So, while there are some risks to his insurance book, his biggest exposure is $66mm in cat risk (catastrophe risk ala hurricanes, etc). This is $66 on a book of $810mm, relatively minor. Overall though, the key is that they run the insurance business P&L neutral, or flat net income so that they can retain the premiums for investing purposes.
Generally given the natural disasters this year (tsunami's in Japan, fires in Australia), most expect pricing on the insurance side to firm up, which should bode well for 2012. Pricing has been horrible the last 18 months as there were few natural disasters and capital levels in the insurance industry got pretty high. Net net, looking at the numbers below, you can see that in 2010 & 2011 to date, they incurred only small losses on the insurance side despite the weak environment, but positive insurance net income in 2008 and 2009.
Most importantly, the company books reserves for future losses in a fairly conservative manner. When you see banks or insurers taking write-downs, you really can't ignore them. They are the result of under-reserving for future bad loans or future insurance losses. It's bad underwriting and speaks to poor management. At GLRE, they have had reduced loss reserves in later years, meaning they actually slightly over-estimated future losses on the balance sheet, and increased net income later to adjust for this.
This is good, clearly the insurance business at Greenlight isn't very likely to hurt you, and in fact could help you some.
The Meat
The important side of the business is Einhorn managing the float, or your money if you buy the stock. While he has only beat the market by 10% cumulatively since 2005, he does so with far less risk. He runs a long-short equity book, typically 50-100% gross long, vs 25-75% gross short. I am generallizing here, as he modifies his net long exposure to fit within his view of the market. In 2008, he was actually only down 17.6%, vs the market down 37%. Then in 2009, he was up 32% while the market returned only 27%. I have seen him speak several times and met him once, and can tell you first hand: this guy is lightyears better than almost anyone in the business.
Here is what Einhorn said from GLRE's quarterly call last week:
"The Greenlight Re investment portfolio ended the month [July] approximately 87% long and 62% short, down from 93% long and 70% short at the end of the second quarter. We believe there are quite a few stocks and sectors such as REITs that are trading at all time highs, are overvalued and we are short some of them. It is our belief that the global economic situation has deteriorated so far this year and is in worse shape than we thought it would be at this point in the cycle.
Given these concerns in addition to consolidating our long and short positions and our highest conviction investments in maintaining a modest debt long position, we continue to hold a significant position in gold, some sovereign CDS, options on higher interest rates and a few currency positions and hedges. We reduced exposures because we believe the opportunity set had become less attractive. Though we don’t usually comment on mid-month performance given the recent market volatility, we believe it's important to provide some additional commentary.
In recent days, the market has suffered a very large decline. Our conservatively positioned portfolios held up reasonably well with gains in the short portfolio and gold almost offsetting losses in our long portfolio. We have taken the opportunity of falling prices to cover some shorts and make modest long investments. As of now our quarter-to-date performance is approximately flat. We are approximately 86% long and 53% short.
Bullish Case
Lots to like here: 1) NAV (or rather Book Value per share) is flat since June 30th, while the market is getting crushed. Yes GLRE itself has gotten crushed, but that just means you can now buy it at a mere 7% premium to NAV. It was as high as a 40% premium to NAV at the peak. The stock has traded from $28 just a few months ago, to $21.75 today. Book value has fallen from $21.39 to $19.82 in that time.
2) Exposure is light, and he has a big position in physical gold, which is performing well.
3) He owns credit default swaps (CDS) on European sovereigns, which are blowing out. In the event of a complete liquidity meltdown, he will make money as interest rates skyrocket. If there is a default, he will make tons of money. I wish I could buy European sovereign CDS in my PA.
4) with the stock at 1.07x book value and with losses expected to mitigate on the insurance side, its pretty cheap. The stock has historically traded around 1.25x book.
As far as his long positions, his top 5 are:
These are names I like, and in fact have 3 in my own portfolio.
So, the S&P is down 7.5%, his top longs are only down 2.2%. Pretty solid. But what I like best about GLRE is that I don't think its a carefully followed name. Case in point: they publish their returns on their portfolio every month, so in theory you shouldn't be that surprised when they report quarterly earnings. In May however, the stock fell 7% after reporting negative earnings. While the monthly numbers were published on their website well in advance, a 4% hit to BV/share caused an abnormally large 7% decline in the stock. Strange.
This month, I am hopeful that traders are panic selling a stock whose BV/share (or NAV as I call it too) is roughly flat since June 30th. In a bull market, this stock likely could trade at 1.3 to 1.4x book, or approximately $26-28 a share. In fact it was $28 earlier this year. Further, if the bull market re-asserts itself and book grows as it has historically, then a $22 book could translate into upside of $29-30 a share.
Downside
The stock IS correlated to the markets. It's one to buy on a dip, as it has lately. Einhorn controls risk in bear markets, but it is almost impossible to make money when risk aversion translates into unbridled selling. This was the case in 2008. But if markets fall another 20%, I would expect GLRE's portfolio to perhaps fall 5-10%, given his net long position of 30% today. Worst case, the stock falls to a book value multiple, and book value itself falls say 8% to $18.25. From $21.75 to $18.25, down $3.50 a share or down 16%.
It might be smart to buy half a position now, and wait for a pullback to buy more.
Upside
Compared to a bull case of $30/share or up 38%, the risk reward is certainly skewed to the upside. I also think that there will be early warning signals to get a read on earnings. Their website provides monthly investment returns. Weakness there coupled with strength in the stock would be a clear sell signal (as was the case earlier this year). Alternatively, decent monthlies lately against a beaten up stock should equate to a buy.
Finally, if you are a buy and hold guy, this stock is probably perfect for you. You get one of the best hedge fund managers in the business for a smidgen above book value. He manages risk far better than a mutual fund. Sure he charges a hefty 2% & 20% to manage the GRLE book, but his returns net of fees are also fantastic. Plus, he can short stocks, European sovereigns, go long in an appropriate way. Mutual funds are all pigeon-holed into one strategy, and run either 95% or 100% long without any short positions.
Since 2005, book per share has grown over 80% cumulatively or 11% per year compounded. If that happened over the next 6 years, I would not complain, nor would I be surprised.
Macro risks to keep in mind:
1) Economic concerns in the US, as slowing government spending and weak consumer spending might push the US into a recession next year. I think odds are better than 50% we'll double dip so to speak. Even if we don't double dip, GDP growth in the first half of this year was a meager 0.9%, and the trend is not your friend right now.
2) European banks, which hold so much European sovereign debt, that there actually could be a liquidity crisis in the next 3 months. With French bank BNP Paribas down 24% intraday last week, liquidity fears are clearly beginning to boil over. It was summer 2008 that stocks like MS, MER, GS, LEH were getting hit 10% - 20% per day. Eventually the Fed let Lehman go under, but then reversed course and bailed out the entire banking system via $800BB of TARP money. It didn't stop financials from collapsing and the equity markets to fall 37%. Today it's the European financial system. Leverage among these banks is as high as it was in 2007. It got very ugly in 2008 amidst the run on the banking system. I honestly expect that the odds of a European bank panic are close to 100%, I just don't know when. But it is out there.
3) China. Yes, China has been the savior to the world's economy since 2008. Pumping capital into infrastructure projects, lending money to consumers at an astronomical pace, loading up on commodities worldwide. But when 60% of your GDP is derived from fixed asset investments (ie infrastructure projects), there is massive downside risk to spending. Because FAI is not recurring in nature, eventually it has to revert to normalized levels. FAI growth was 67% in 2009, 33% in 2010, and 25% in the first half of 2011. I read that FAI growth accounted for 8% of their 8.7% growth in GDP last year. When will China simply reach a level of overcapacity and slow down? It's not consumer spending driving GDP in China, its the government.
Greenlight RE
So, looking for defensive stocks makes sense to me, but also one perhaps that has some upside if the market rallies. The one I recommend buying now is Greenlight RE, ticker GLRE. Greenlight is technically an insurance company. They underwrite a variety of property and casualty reinsurance, but the reality is that it's essentially an investment in a hedge fund, but one with daily liquidity despite that fact that NAV is published only quarterly.
So, why GLRE in this market?
First of all, GLRE is only 30% net long right now. That is, their portfolio is heavily hedged. If the market falls 20%, then GLRE's portfolio will fall far less than the market, perhaps only 5-6%. Second, you have to understand the track record of David Einhorn who manages the money for GLRE. Einhorn's hedge fund has racked up double digit returns in all but 3 years since 1996, when he launched Greenlight Capital. In 2004, he started Greenlight RE, patterned somewhat after Berkshire Hathaway. Essentially, he sells insurance policies and then invests the float in public equities. Through the insurance premiums he collects, he essentially gets free, long-dated capital, assuming you can at least run your insurance business at a 100% combined ratio. That is, without losses or at a breakeven level.
Boring Insurance Stuff
So, Einhorn raised $200mm back in 2005 via an IPO and established a vehicle that essentially invests in his hedge fund called DME Advisors. His firm writes reinsurance property & casualty policies, collects the premium and invests it hedge fund style. So, while there are some risks to his insurance book, his biggest exposure is $66mm in cat risk (catastrophe risk ala hurricanes, etc). This is $66 on a book of $810mm, relatively minor. Overall though, the key is that they run the insurance business P&L neutral, or flat net income so that they can retain the premiums for investing purposes.
Generally given the natural disasters this year (tsunami's in Japan, fires in Australia), most expect pricing on the insurance side to firm up, which should bode well for 2012. Pricing has been horrible the last 18 months as there were few natural disasters and capital levels in the insurance industry got pretty high. Net net, looking at the numbers below, you can see that in 2010 & 2011 to date, they incurred only small losses on the insurance side despite the weak environment, but positive insurance net income in 2008 and 2009.
| 2008 | 2009 | 2010 | 2011 | ||
| Combined Ratio | 96.50% | 96.50% | 102.80% | 102.10% | |
Most importantly, the company books reserves for future losses in a fairly conservative manner. When you see banks or insurers taking write-downs, you really can't ignore them. They are the result of under-reserving for future bad loans or future insurance losses. It's bad underwriting and speaks to poor management. At GLRE, they have had reduced loss reserves in later years, meaning they actually slightly over-estimated future losses on the balance sheet, and increased net income later to adjust for this.
| Loss reserves | Chg in NI | ||||
| 2010 | 8678 | -8678 | |||
| 2009 | -7597 | 7597 | |||
| 2008 | -11988 | 11988 | |||
| 2007 | -1077 | 1077 | |||
This is good, clearly the insurance business at Greenlight isn't very likely to hurt you, and in fact could help you some.
The Meat
The important side of the business is Einhorn managing the float, or your money if you buy the stock. While he has only beat the market by 10% cumulatively since 2005, he does so with far less risk. He runs a long-short equity book, typically 50-100% gross long, vs 25-75% gross short. I am generallizing here, as he modifies his net long exposure to fit within his view of the market. In 2008, he was actually only down 17.6%, vs the market down 37%. Then in 2009, he was up 32% while the market returned only 27%. I have seen him speak several times and met him once, and can tell you first hand: this guy is lightyears better than almost anyone in the business.
Here is what Einhorn said from GLRE's quarterly call last week:
"The Greenlight Re investment portfolio ended the month [July] approximately 87% long and 62% short, down from 93% long and 70% short at the end of the second quarter. We believe there are quite a few stocks and sectors such as REITs that are trading at all time highs, are overvalued and we are short some of them. It is our belief that the global economic situation has deteriorated so far this year and is in worse shape than we thought it would be at this point in the cycle.
Given these concerns in addition to consolidating our long and short positions and our highest conviction investments in maintaining a modest debt long position, we continue to hold a significant position in gold, some sovereign CDS, options on higher interest rates and a few currency positions and hedges. We reduced exposures because we believe the opportunity set had become less attractive. Though we don’t usually comment on mid-month performance given the recent market volatility, we believe it's important to provide some additional commentary.
In recent days, the market has suffered a very large decline. Our conservatively positioned portfolios held up reasonably well with gains in the short portfolio and gold almost offsetting losses in our long portfolio. We have taken the opportunity of falling prices to cover some shorts and make modest long investments. As of now our quarter-to-date performance is approximately flat. We are approximately 86% long and 53% short.
Bullish Case
Lots to like here: 1) NAV (or rather Book Value per share) is flat since June 30th, while the market is getting crushed. Yes GLRE itself has gotten crushed, but that just means you can now buy it at a mere 7% premium to NAV. It was as high as a 40% premium to NAV at the peak. The stock has traded from $28 just a few months ago, to $21.75 today. Book value has fallen from $21.39 to $19.82 in that time.
2) Exposure is light, and he has a big position in physical gold, which is performing well.
3) He owns credit default swaps (CDS) on European sovereigns, which are blowing out. In the event of a complete liquidity meltdown, he will make money as interest rates skyrocket. If there is a default, he will make tons of money. I wish I could buy European sovereign CDS in my PA.
4) with the stock at 1.07x book value and with losses expected to mitigate on the insurance side, its pretty cheap. The stock has historically traded around 1.25x book.
As far as his long positions, his top 5 are:
| Month of August Returns | |
| AAPL | -3.78% |
| GLD | 7.64% |
| MSFT | -7.08% |
| VOD | -2.56% |
| PFE | -5.04% |
| Top 5 | -2.16% |
These are names I like, and in fact have 3 in my own portfolio.
So, the S&P is down 7.5%, his top longs are only down 2.2%. Pretty solid. But what I like best about GLRE is that I don't think its a carefully followed name. Case in point: they publish their returns on their portfolio every month, so in theory you shouldn't be that surprised when they report quarterly earnings. In May however, the stock fell 7% after reporting negative earnings. While the monthly numbers were published on their website well in advance, a 4% hit to BV/share caused an abnormally large 7% decline in the stock. Strange.
This month, I am hopeful that traders are panic selling a stock whose BV/share (or NAV as I call it too) is roughly flat since June 30th. In a bull market, this stock likely could trade at 1.3 to 1.4x book, or approximately $26-28 a share. In fact it was $28 earlier this year. Further, if the bull market re-asserts itself and book grows as it has historically, then a $22 book could translate into upside of $29-30 a share.
Downside
The stock IS correlated to the markets. It's one to buy on a dip, as it has lately. Einhorn controls risk in bear markets, but it is almost impossible to make money when risk aversion translates into unbridled selling. This was the case in 2008. But if markets fall another 20%, I would expect GLRE's portfolio to perhaps fall 5-10%, given his net long position of 30% today. Worst case, the stock falls to a book value multiple, and book value itself falls say 8% to $18.25. From $21.75 to $18.25, down $3.50 a share or down 16%.
It might be smart to buy half a position now, and wait for a pullback to buy more.
Upside
Compared to a bull case of $30/share or up 38%, the risk reward is certainly skewed to the upside. I also think that there will be early warning signals to get a read on earnings. Their website provides monthly investment returns. Weakness there coupled with strength in the stock would be a clear sell signal (as was the case earlier this year). Alternatively, decent monthlies lately against a beaten up stock should equate to a buy.
Finally, if you are a buy and hold guy, this stock is probably perfect for you. You get one of the best hedge fund managers in the business for a smidgen above book value. He manages risk far better than a mutual fund. Sure he charges a hefty 2% & 20% to manage the GRLE book, but his returns net of fees are also fantastic. Plus, he can short stocks, European sovereigns, go long in an appropriate way. Mutual funds are all pigeon-holed into one strategy, and run either 95% or 100% long without any short positions.
Since 2005, book per share has grown over 80% cumulatively or 11% per year compounded. If that happened over the next 6 years, I would not complain, nor would I be surprised.
Wednesday, June 1, 2011
Ira Sohn Conference 2011
I ventured to NY last week, to partake in the Ira Sohn Conference. Put on by my old boss Dan Nir and his colleague Doug Hirsch, its a great buyside event with a dozen or so top quality hedge fund presenters. Carl Icahn, David Einhorn and a dozen other moguls presented, including Marc Faber who is always one of my favorites too. The format is that these normally secretive hedge fund gazillionaires discuss their favorite stock idea, all for a great kids charity. The event has become so big, that within seconds of a hedge fund presentor identifying which stock he likes, it immediately pops in the open market. So, read this. These ideas cost $4,000 a ticket.
Erez Kalir, Sabretooth
Very smart speaker, Kalir discussed the macroeconomic environment in the US under the heading "Economic Death." It was a nice way to jump start things. His focus was how investors tended to overestimate, or underestimate probabilities of binary events. Ie, the market is currently underestimating the chance of US financial death, by which he means default, or defacto default via hyperinflation. In 2002, Argentina defaulted on $132BB in bonds, at the time the largest in history. The dollar peg was removed, investors got scorched not only in the bonds, but also in Argentine stocks because of the currency devaluation.
However, today Argentina is still "widely hated" and "uninvestable." That makes it attractive, as default is unlikely to re-occur, and its in the early stages of a land grab, improved infrastructure and energy deregulation. He specifically likes Argentine E&P companies, as energy deregulation likely will drive oil & gas prices back to market levels. His top idea here was YPF SA (YPF), also mentioning CWV CN, BOE CN, MVN CN, RPT CN.
As for the US, he says that the US fiscal situation is heading "toward an accident." Gold can be confiscated, even internationally owned gold, which happened in 1961. He recommended not shorting treasuries either, however. History suggests that the best assets to own in a financial system meltdown is farmland. Namely, INTERNATIONAL farmland. Good luck buying acreage in Tuscany was all I could think. Stocks with pricing power also could provide inflation protection, which clearly the Fed is indicating it intends to create.
Finally, he also recommended buying MBIA, which is another name "left for dead." Its humongous legacy structure product liabilities have been separated legally from the remaining business (which challenges will fail he believes). That means its remaining muni guarantee business is undervalued; its trading 1/3 of book today. This was a huge hedge fund short throughout the crisis in 2007-2009. Ticker is MBI, personally I would be careful owning this, its a total spec. I loved the YPF idea though.
Dinaker Singh, TPG-Axon Capital
Dinaker Singh recommended 3 stocks:
ORKLA, a Norwegian holding company with solar assets, aluminum assets, and cash & investments. Stock trades in Oslo, around 50 Kroner per share, and is worth 65-79 a share he believes. With anticipated special dividends on the way, and high likelihood of it splitting into several pieces, he believes you could realize this value soon. Without any restructuring however, you are still holding a nice stock with a >5% dividend yield, at 9-10x earnings, indicating that the downside is low.
Zhongpin, US ticker HOGS. This Chinese pork processing company has underperformed the market by 15-30% in the last 6 months. Asia has been de-rated (ie multiple compression), inflation has hurt earnings, and there are fears that the Chinese government will not let Zhongpin raise prices to offset higher input costs. However, it trades at 7-8x forward earnings, they continue to gain market share, and he expects earnings to grow by 50% by 2013, to $3.00 a share. At $15, he thinks it could be a double.
Sprint Nextel, ticker S. Also a recent name purchased by David Einhorn, Singh believes that the tide is finally turning for Sprint. Churn, net subscriber adds, customer service, ARPU, are all finally trending in the right direction. The merger of AT&T and T-Mobile is a good thing for the industry. His research shows that fewer players in an industry equates to better margins. Sprint needs to spend $2BB to consolidate its Nextel legacy network, but in a couple years he thinks the stock could be worth $8 to $13 a share. Today its at $5.75. My take: a long term play, wait for a better entry point, chart is extended.
Jeff Aronson, Centerbridge
Formerly the head of distressed at Angelo Gordon, Jeff pitched CIT Corp. A name that I consider a somewhat old distressed name, its still owned by a pile of hedge funds, and is somewhat a hedge fund hotel. That said, he gave a compelling pitch. He listed its various finance businesses (aircraft, office equipment, factory equipment, etc), and suggested that real book value needs to be adjusted from its stated $45/share value. Accounting adjustments and deferred tax assets on top of its stated book gets you $59/share. With the stock at $41 today, its trading at a mere 0.7x book.
Further, it has a 2010 asset yield of 8.0%, vs banks asset yields of 4.6%. Its cost of funds is very high, at 7.2%. That means its only earning 0.8% (80bps) in spread. Commercial banks have a cost of funds of 1.0%, implying that there is massive synergy to CIT either acquiring commercial deposits via a bank acquisition, or similarly huge synergy for a bank to buy CIT. Its tier one capital ratio is also very high at 20%, better than the bank average of 12% today.
While Aronson thinks EPS standalone will be $1.76 in 2012, (making the stock look expensive), a CIT merger with a commercial bank could equate to a combined $5.83 in EPS. Hypothetically speaking. Net net, CIT at $41 today could be worth $58-65 a share. My take: expensive on current earnings which clearly are impossible to predict, book value adjustments that I question, but sure lots of upside if they get bought.
Bob Howard, head of KKR Equity Strategies Group
Howard liked 2 stocks:
Wabco, ticker WBC. Wabco is a $4.5BB market cap auto supplier, including electronic and mechanical components. WBC invented anti-lock brakes. The stock has been penalized for potential litigation overhangs, which now are behind them. While the market feared a $1BB fine, it turned out to be $400mm, which they reserved for in Q4 2010. 60% of revenue in western Europe also scares investors, however he noted that 1/2 of this is Germany, and the other half is exported outside of Europe.
With the stock at $67 today, Howard believed it should be worth $100 a share today. 40% of the business is cyclical, 40% a secular growth story. Using appropriate multiples for each, he finds that the stock trades on par with industry peers, but is a far better company. ROE's are top notch at 22%, EPS has grown 38% in the last 5 years, and finally the CEO owns $200mm of stock. I liked this one.
HSNI, Home Shopping Network. 32% owned by Liberty Interactive, HSNI competes against QVC in home shopping. Its a $1.8BB market cap company, with debt of 1.2x EBITDA. At $32/share, its important to note that 1/3 of HSN sales are online, the company has only 1% retail market share, and sales are up 6% CAGR since 1994. At 5.7x EBITDA, it's worth 7.0x, in line with comps. Its ROE is huge at 29%, and you can buy it for only a 12.0x P/E multiple on 2012 numbers. Other retailers generate 15-17% ROEs. Since Liberty also owns QVC, there is merger potential here. I liked this pitch, but stock jumped to $35 in 3 days of trading since.
Phil Falcone, Harbinger
The famously successful, then famously unsuccessful hedge fund investor pitched his biggest investment, LightSquared. Which isn't even public. He believes their spectrum is worth a fortune, despite the fact that he needs some $5 or 10 BB in additional capital to deploy the network. He insists it's a terrestrial network, not a satellite network.
Phil also pitched Crosstex, XTXI. A classic distressed guy, he outlined the legal structure, showed how you were buying 100% of 3 different assets, including the GP of XTEX as well as LP units in XTEX. XTEX owns natgas pipelines and processing facilities. The GP entitles you to incentive distribution rights, or IDRs. Any hedge fund employee knows the value and leverage that IDR's provide you. Given the XTEX stock that XTXI owns, and its GP structure of XTEX, a 30% increase in dividends at XTEX imply a 90% increase in dividends at XTXI. With XTEX organically growing 10-15%, net net XTXI could be an $18-20 stock in a couple years, from $9.50 today.
Note that XTEX (and XTXI) is essentially a long oil/short gas trades. As a processor, XTEX makes money buying natgas, then processing and selling a spread of that in the form of NGLs and gas. Natgas volume is also very important. So, make sure you know which way both oil and gas are going. (hopefully, oil up, gas down.). Stock has spiked to $11.30 since last week.
Jim Chanos, Kynikos
Chanos is perhaps the best known shortseller out there, famously calling Enron a short back in 2001. His theme was the overvaluation of green energy stocks, titled "Solar + Wind = Hot Air". Solar and wind energy are highly unreliable, need backup, and pose major grid issues. They could never be a sub for baseload power. Both require huge subsidies to work, they are not efficient, with wind 50% more expensive than natgas, and solar 4x more expensive.
2010 wind installations were down 40% vs 2009, while at the same time competition is heating up with new Chinese entrants. Particularly, he likes shorting Vestas (VWS DC). Business is down, 3000 layoffs were recently announced, it changed its accounting recently, pulling forward revenue and deferring costs, and it lost 600mm Euros in FCF.
First Solar (FSLR) was his favorite short here. Spain in 2008 represented 40% of total solar demand worldwide, Germany was 50% in 2009, and Italy was 25% in 2010. [unsaid was how unstable govt subsidized demand would be in these countries]. Demand will likely decline while competition increases. FSLR also uses thin film technology, which is inferior to poly technology. They will be negative FCF in 2011, spending more and more capex to generate less and less earnings. The balance sheet is deteriorating, they pay no taxes, management is selling stock, and the former CEO sold 75% of his shares. The new CEO and CFO are inexperienced in solar.
Michael Price, MFP Investments
The famous value investor introduced a contest winner. Before the winner presented his stock however, Price mentioned that GS and C and BAC are all trading below tangible book, at low multiples, and reminds him of the environment in 1991, when financials were beaten up back then and trading cheaply. He also threw out ITT, JCP, and Becton Dickenson (BDX). All good stocks to own in the face of a weak dollar. Goldman, GS, he suggested was worth $100 more than today ($135 now). "Tremendous businesses, honest people, a good value."
Then Sunjay Gorawara, a student at the U of Indiana, presented Bridgepoint Education (BPI). GM's are 74%, revenue has been growing 30%, 31% of the stocks market cap is in cash, and it trades at 4.3x earnings. 58% of the earnings float is short the stock, despite its low valuation. Education stocks were presented as a short last year by Steve Eisman (Apollo, Strayer, et al). Perhaps its time to get long?
Steve Feinberg, Cerberus
Perhaps a guy I have admired more than anyone in the last 10 years, I was honestly disappointed by his presentation. Lacking slides, a coherent presentation, or anything interesting to say about the world at all, Steve discussed in a rambling way why he liked non-agency mortgage bonds. I swear at one point he said, "Loan size is now more important than it used to be. Large balance pools are performing better than smaller sized pools of mortgages." or "Regional differences are important to loan pools." Awesome. Next.
Peter May, Trian Fund Management
Peter made a compelling pitch why retail analysts in the US inappropriately value Tiffany's. TIF should be likened to global luxury conglomerate brands, not department retailer in the US. Margins are higher, growth is continuing via 1) new stores, 2) increases in same store sales, and 3) vertical integration like offering Tiffany brand watches to other retailers. They have 233 stores today, up from 167 stores five years ago. Its trading at 17.5x 2012 EPS, and international growth will continue to drive earnings growth. One acquisition was for over 30x earnings (I think it was Bulgari).
The day after the conference, TIF reported earnings, which were fantastic, and the stock was up $6, to $76 per share. Guess I should have bought some during his pitch.
Steve Eisman, Frontpoint Partners
Eisman was one of the guys profiled in Michael Lewis' The Big Short. A very astute financials analyst, Eisman discussed financials and banks in the US. He outlined why the bullish case on banks was likely not to work out by 2012. That is, Fed Funds will likely stay low, pressuring net interest margins (NIM). Credit quality is perhaps improving some, but loan growth is nil. Without topline growth, there is little reason to buy the banks.
So, Eisman outlined why he likes the P&C sector, particularly on the commercial side. Trading at similar multiples to book value and P/E as banks, insurers aren't burdened with residential mortgages on their balance sheets. Most importantly, he likes property & casualty stocks because the soft pricing environment is about to end. Tragedies in New Zealand, Japan, the US (tornadoes), have created lots of losses this year (85BB), that insurers now need to compensate for. He expects prices to be up 5-10% for 2011, and this "hard" pricing environment to last for some time. Stocks to buy: ACE, ARCH, AXS, ENH, MRH, PRE, PTP, RE, RNR, XL. These trade at 9.3x 2012 EPS on average. Brokers to buy: AON, MMC, WSH.
Jeff Gundlach, Double Line
Jeff is a well known fixed income mutual fund manager, sometimes likened as a young Bill Gross. His sordid breakup from TCW has hurt his reputation and ability to raise capital, but he's not lacking smarts. He discussed the bleakness of our macro environment, particularly the US' Debt/GDP ratio at 353%. He described our fiscal policy as one of "hope and pray", suggesting that we are doomed even if we somehow froze gov't spending and grew GDP at 6% a year for 10 years. Housing also he was bearish on, suggesting supply is very high, as is home ownership rates. He does not like gold, preferring instead gems, which you can fit $25mm of gems in your shoe and still wear it. Gold & silver present storage difficulties, but perhaps only if you have $25mm of it worry about.
His fund, DLTNX, hasn't been around very long, but I think its worth a buy. Especially vs Pimco's Total Return Fund, which is 250BB. Double Line is running a "mere" 7BB, far easier to generate better returns.
Marc Faber, Gloom Boom & Doom
Faber as usual railed against the Fed. His basic thesis was that Federal Reserve monetary policy creates frequent and unintended consequences. Excess credit from the Fed = bubbles. At our current level of Debt/GDP, the US will be able to do nothing except "print and print and print" dollars. Their monetary philosophy is strangely that they cannot identify bubbles, ignoring them at our peril. Commodity prices tend to go ballistic in easy credit regimes, he also defended gold as something that is more likely to be used to pay for goods than gems.
Bill Ackman, Pershing Square
Gave a very concise, quick pitch on FDO, Family Dollar. A $54 stock, he sees 35-70% upside, primarily from improving operations and margins to make it comparable to Dollar General, a KKR owned competitor. For years, both DG and FDO operated at similar margins, similar top line growth rates. After KKR took over DG in July 2007, it began to outperform. Global sourcing of product, providing more private label goods (which are higher margin) would close the gap. EBIT margins at FDO are 7.6% v 10.5% at Dollar General. A buyer could pay $75+ for the stock, and upside could be as high as $95 a share from $54 today.
Mark Hart, Corriente Advisors
Perhaps the most eye-opening presentation of the day, Hart detailed why China is a credit fueled bubble that is very likely to pop. He noted several misconceptions about China: 1) it is not an economic miracle as most believe. Huge increases in Money Supply M2 have fueled credit growth that is unsustainable. M2 there is greater than the M2 of the US, despite the fact that the economy is only 40% as big as the US. Lending has increased by 70% since 2008 alone, and now is 125% of GDP. On top of that, NPL (non-performing loans) are reportedly DOWN since then. Not likely.
Also, look at prior Asian bubbles that blew up, notably Korea, Thailand and Malaysia. These countries' Fixed Asset Investments (FAI) as a % of GDP peaked between 40-45% leading up their busts in 1998. China today is spending 60% of GDP on infrastructure, or FAI. Local government borrowing is also out of control. Only 65% of local spending is affordable with cash inflows, the rest comes from asset sales.
Misconception #2: China's foreign currency reserves are savings. Truth is, there are corresponding liabilities. M2 = 12 TT (liabilities). Compare that to their FX reserves, and the ratio is only 25%. This ratio was 28% in prior Asian crises.
Misconception #3: The yuan will continue to appreciate. Hart believes that devaluation is actually the path of least resistance here. The only bull case for the yuan is capital flows into the country. But as soon as the bubble of infrastructure spending stops, these capital flows will also stop. The exit will lead to outflows and the yuan devaluing.
Trade: Buy 1 year at the money puts on RMB (yuan). Cost is 25bps, upside could be 100x your capital.
David Einhorn, Greenlight Capital
Always the best presenter, Einhorn outlined the bull case for Delta Lloyd, DL NA. Its a Dutch insurer trading at 15.50 Euro / Share with a 2.6BB market cap. Its trading at 6x EPS, with a 6% dividend yield. Its a life and pension company, 80% invested in Fixed Income, 20% equities. Its highly levered to the economy, and a 1% move in stocks equates to 20c in EPS. While TTM EPS is 3.75 (6x P/E), likely they'll do 2.25 EPS in 2010, as market returns decline.
Einhorn then revisited his pitch on Microsoft, MSFT. Five years ago he pitched MSFT at around $25/share, when the stock was doing $1.25 in EPS. Today, its doubled its EPS to $2.50, but the stock is flat. That is, P/E ratio has fallen from 15.6x to 7.3x. He outlined the misses that the company has suffered: social media, search, tablets, phone operating systems, application hosting, etc etc. Its success in office and enterprise software is overcome by its "miserable capital allocation plan." Case in point, trying to buy Yahoo! for $30+ a share. Only managers crazier than MSFT kept them from doing a terrible deal.
Then Einhorn began to systematically take apart Steve Ballmer. He compared him to Charlie Brown trying to kick a field goal with Lucy holding the football. He showed quotes of Ballmer back in 2008 saying things like, "Am I worried about the iPhone? No, maybe they'll get 2% or 3% market share." He listed all of the top senior managers who have left Microsoft under his Windows/Office only culture. Finally, he suggested change is needed, "someone else needs a turn at Quarterback." Great speech, I personally have tried to own MSFT, and not really made money. The cheap get cheaper, but at some point, there is a bottom.
Carl Icahn, Icahn Partners
I left just as Carl began to speak. He always rambles about how he shakes up boards, how his activism enhances shareholder value. He supposedly pitched his own stock, IEP after detailing why he gave back his investors money. The reason? He didnt want to be responsible for the losses that are likely in the market in a year or two. A stellar ending!
Erez Kalir, Sabretooth
Very smart speaker, Kalir discussed the macroeconomic environment in the US under the heading "Economic Death." It was a nice way to jump start things. His focus was how investors tended to overestimate, or underestimate probabilities of binary events. Ie, the market is currently underestimating the chance of US financial death, by which he means default, or defacto default via hyperinflation. In 2002, Argentina defaulted on $132BB in bonds, at the time the largest in history. The dollar peg was removed, investors got scorched not only in the bonds, but also in Argentine stocks because of the currency devaluation.
However, today Argentina is still "widely hated" and "uninvestable." That makes it attractive, as default is unlikely to re-occur, and its in the early stages of a land grab, improved infrastructure and energy deregulation. He specifically likes Argentine E&P companies, as energy deregulation likely will drive oil & gas prices back to market levels. His top idea here was YPF SA (YPF), also mentioning CWV CN, BOE CN, MVN CN, RPT CN.
As for the US, he says that the US fiscal situation is heading "toward an accident." Gold can be confiscated, even internationally owned gold, which happened in 1961. He recommended not shorting treasuries either, however. History suggests that the best assets to own in a financial system meltdown is farmland. Namely, INTERNATIONAL farmland. Good luck buying acreage in Tuscany was all I could think. Stocks with pricing power also could provide inflation protection, which clearly the Fed is indicating it intends to create.
Finally, he also recommended buying MBIA, which is another name "left for dead." Its humongous legacy structure product liabilities have been separated legally from the remaining business (which challenges will fail he believes). That means its remaining muni guarantee business is undervalued; its trading 1/3 of book today. This was a huge hedge fund short throughout the crisis in 2007-2009. Ticker is MBI, personally I would be careful owning this, its a total spec. I loved the YPF idea though.
Dinaker Singh, TPG-Axon Capital
Dinaker Singh recommended 3 stocks:
ORKLA, a Norwegian holding company with solar assets, aluminum assets, and cash & investments. Stock trades in Oslo, around 50 Kroner per share, and is worth 65-79 a share he believes. With anticipated special dividends on the way, and high likelihood of it splitting into several pieces, he believes you could realize this value soon. Without any restructuring however, you are still holding a nice stock with a >5% dividend yield, at 9-10x earnings, indicating that the downside is low.
Zhongpin, US ticker HOGS. This Chinese pork processing company has underperformed the market by 15-30% in the last 6 months. Asia has been de-rated (ie multiple compression), inflation has hurt earnings, and there are fears that the Chinese government will not let Zhongpin raise prices to offset higher input costs. However, it trades at 7-8x forward earnings, they continue to gain market share, and he expects earnings to grow by 50% by 2013, to $3.00 a share. At $15, he thinks it could be a double.
Sprint Nextel, ticker S. Also a recent name purchased by David Einhorn, Singh believes that the tide is finally turning for Sprint. Churn, net subscriber adds, customer service, ARPU, are all finally trending in the right direction. The merger of AT&T and T-Mobile is a good thing for the industry. His research shows that fewer players in an industry equates to better margins. Sprint needs to spend $2BB to consolidate its Nextel legacy network, but in a couple years he thinks the stock could be worth $8 to $13 a share. Today its at $5.75. My take: a long term play, wait for a better entry point, chart is extended.
Jeff Aronson, Centerbridge
Formerly the head of distressed at Angelo Gordon, Jeff pitched CIT Corp. A name that I consider a somewhat old distressed name, its still owned by a pile of hedge funds, and is somewhat a hedge fund hotel. That said, he gave a compelling pitch. He listed its various finance businesses (aircraft, office equipment, factory equipment, etc), and suggested that real book value needs to be adjusted from its stated $45/share value. Accounting adjustments and deferred tax assets on top of its stated book gets you $59/share. With the stock at $41 today, its trading at a mere 0.7x book.
Further, it has a 2010 asset yield of 8.0%, vs banks asset yields of 4.6%. Its cost of funds is very high, at 7.2%. That means its only earning 0.8% (80bps) in spread. Commercial banks have a cost of funds of 1.0%, implying that there is massive synergy to CIT either acquiring commercial deposits via a bank acquisition, or similarly huge synergy for a bank to buy CIT. Its tier one capital ratio is also very high at 20%, better than the bank average of 12% today.
While Aronson thinks EPS standalone will be $1.76 in 2012, (making the stock look expensive), a CIT merger with a commercial bank could equate to a combined $5.83 in EPS. Hypothetically speaking. Net net, CIT at $41 today could be worth $58-65 a share. My take: expensive on current earnings which clearly are impossible to predict, book value adjustments that I question, but sure lots of upside if they get bought.
Bob Howard, head of KKR Equity Strategies Group
Howard liked 2 stocks:
Wabco, ticker WBC. Wabco is a $4.5BB market cap auto supplier, including electronic and mechanical components. WBC invented anti-lock brakes. The stock has been penalized for potential litigation overhangs, which now are behind them. While the market feared a $1BB fine, it turned out to be $400mm, which they reserved for in Q4 2010. 60% of revenue in western Europe also scares investors, however he noted that 1/2 of this is Germany, and the other half is exported outside of Europe.
With the stock at $67 today, Howard believed it should be worth $100 a share today. 40% of the business is cyclical, 40% a secular growth story. Using appropriate multiples for each, he finds that the stock trades on par with industry peers, but is a far better company. ROE's are top notch at 22%, EPS has grown 38% in the last 5 years, and finally the CEO owns $200mm of stock. I liked this one.
HSNI, Home Shopping Network. 32% owned by Liberty Interactive, HSNI competes against QVC in home shopping. Its a $1.8BB market cap company, with debt of 1.2x EBITDA. At $32/share, its important to note that 1/3 of HSN sales are online, the company has only 1% retail market share, and sales are up 6% CAGR since 1994. At 5.7x EBITDA, it's worth 7.0x, in line with comps. Its ROE is huge at 29%, and you can buy it for only a 12.0x P/E multiple on 2012 numbers. Other retailers generate 15-17% ROEs. Since Liberty also owns QVC, there is merger potential here. I liked this pitch, but stock jumped to $35 in 3 days of trading since.
Phil Falcone, Harbinger
The famously successful, then famously unsuccessful hedge fund investor pitched his biggest investment, LightSquared. Which isn't even public. He believes their spectrum is worth a fortune, despite the fact that he needs some $5 or 10 BB in additional capital to deploy the network. He insists it's a terrestrial network, not a satellite network.
Phil also pitched Crosstex, XTXI. A classic distressed guy, he outlined the legal structure, showed how you were buying 100% of 3 different assets, including the GP of XTEX as well as LP units in XTEX. XTEX owns natgas pipelines and processing facilities. The GP entitles you to incentive distribution rights, or IDRs. Any hedge fund employee knows the value and leverage that IDR's provide you. Given the XTEX stock that XTXI owns, and its GP structure of XTEX, a 30% increase in dividends at XTEX imply a 90% increase in dividends at XTXI. With XTEX organically growing 10-15%, net net XTXI could be an $18-20 stock in a couple years, from $9.50 today.
Note that XTEX (and XTXI) is essentially a long oil/short gas trades. As a processor, XTEX makes money buying natgas, then processing and selling a spread of that in the form of NGLs and gas. Natgas volume is also very important. So, make sure you know which way both oil and gas are going. (hopefully, oil up, gas down.). Stock has spiked to $11.30 since last week.
Jim Chanos, Kynikos
Chanos is perhaps the best known shortseller out there, famously calling Enron a short back in 2001. His theme was the overvaluation of green energy stocks, titled "Solar + Wind = Hot Air". Solar and wind energy are highly unreliable, need backup, and pose major grid issues. They could never be a sub for baseload power. Both require huge subsidies to work, they are not efficient, with wind 50% more expensive than natgas, and solar 4x more expensive.
2010 wind installations were down 40% vs 2009, while at the same time competition is heating up with new Chinese entrants. Particularly, he likes shorting Vestas (VWS DC). Business is down, 3000 layoffs were recently announced, it changed its accounting recently, pulling forward revenue and deferring costs, and it lost 600mm Euros in FCF.
First Solar (FSLR) was his favorite short here. Spain in 2008 represented 40% of total solar demand worldwide, Germany was 50% in 2009, and Italy was 25% in 2010. [unsaid was how unstable govt subsidized demand would be in these countries]. Demand will likely decline while competition increases. FSLR also uses thin film technology, which is inferior to poly technology. They will be negative FCF in 2011, spending more and more capex to generate less and less earnings. The balance sheet is deteriorating, they pay no taxes, management is selling stock, and the former CEO sold 75% of his shares. The new CEO and CFO are inexperienced in solar.
Michael Price, MFP Investments
The famous value investor introduced a contest winner. Before the winner presented his stock however, Price mentioned that GS and C and BAC are all trading below tangible book, at low multiples, and reminds him of the environment in 1991, when financials were beaten up back then and trading cheaply. He also threw out ITT, JCP, and Becton Dickenson (BDX). All good stocks to own in the face of a weak dollar. Goldman, GS, he suggested was worth $100 more than today ($135 now). "Tremendous businesses, honest people, a good value."
Then Sunjay Gorawara, a student at the U of Indiana, presented Bridgepoint Education (BPI). GM's are 74%, revenue has been growing 30%, 31% of the stocks market cap is in cash, and it trades at 4.3x earnings. 58% of the earnings float is short the stock, despite its low valuation. Education stocks were presented as a short last year by Steve Eisman (Apollo, Strayer, et al). Perhaps its time to get long?
Steve Feinberg, Cerberus
Perhaps a guy I have admired more than anyone in the last 10 years, I was honestly disappointed by his presentation. Lacking slides, a coherent presentation, or anything interesting to say about the world at all, Steve discussed in a rambling way why he liked non-agency mortgage bonds. I swear at one point he said, "Loan size is now more important than it used to be. Large balance pools are performing better than smaller sized pools of mortgages." or "Regional differences are important to loan pools." Awesome. Next.
Peter May, Trian Fund Management
Peter made a compelling pitch why retail analysts in the US inappropriately value Tiffany's. TIF should be likened to global luxury conglomerate brands, not department retailer in the US. Margins are higher, growth is continuing via 1) new stores, 2) increases in same store sales, and 3) vertical integration like offering Tiffany brand watches to other retailers. They have 233 stores today, up from 167 stores five years ago. Its trading at 17.5x 2012 EPS, and international growth will continue to drive earnings growth. One acquisition was for over 30x earnings (I think it was Bulgari).
The day after the conference, TIF reported earnings, which were fantastic, and the stock was up $6, to $76 per share. Guess I should have bought some during his pitch.
Steve Eisman, Frontpoint Partners
Eisman was one of the guys profiled in Michael Lewis' The Big Short. A very astute financials analyst, Eisman discussed financials and banks in the US. He outlined why the bullish case on banks was likely not to work out by 2012. That is, Fed Funds will likely stay low, pressuring net interest margins (NIM). Credit quality is perhaps improving some, but loan growth is nil. Without topline growth, there is little reason to buy the banks.
So, Eisman outlined why he likes the P&C sector, particularly on the commercial side. Trading at similar multiples to book value and P/E as banks, insurers aren't burdened with residential mortgages on their balance sheets. Most importantly, he likes property & casualty stocks because the soft pricing environment is about to end. Tragedies in New Zealand, Japan, the US (tornadoes), have created lots of losses this year (85BB), that insurers now need to compensate for. He expects prices to be up 5-10% for 2011, and this "hard" pricing environment to last for some time. Stocks to buy: ACE, ARCH, AXS, ENH, MRH, PRE, PTP, RE, RNR, XL. These trade at 9.3x 2012 EPS on average. Brokers to buy: AON, MMC, WSH.
Jeff Gundlach, Double Line
Jeff is a well known fixed income mutual fund manager, sometimes likened as a young Bill Gross. His sordid breakup from TCW has hurt his reputation and ability to raise capital, but he's not lacking smarts. He discussed the bleakness of our macro environment, particularly the US' Debt/GDP ratio at 353%. He described our fiscal policy as one of "hope and pray", suggesting that we are doomed even if we somehow froze gov't spending and grew GDP at 6% a year for 10 years. Housing also he was bearish on, suggesting supply is very high, as is home ownership rates. He does not like gold, preferring instead gems, which you can fit $25mm of gems in your shoe and still wear it. Gold & silver present storage difficulties, but perhaps only if you have $25mm of it worry about.
His fund, DLTNX, hasn't been around very long, but I think its worth a buy. Especially vs Pimco's Total Return Fund, which is 250BB. Double Line is running a "mere" 7BB, far easier to generate better returns.
Marc Faber, Gloom Boom & Doom
Faber as usual railed against the Fed. His basic thesis was that Federal Reserve monetary policy creates frequent and unintended consequences. Excess credit from the Fed = bubbles. At our current level of Debt/GDP, the US will be able to do nothing except "print and print and print" dollars. Their monetary philosophy is strangely that they cannot identify bubbles, ignoring them at our peril. Commodity prices tend to go ballistic in easy credit regimes, he also defended gold as something that is more likely to be used to pay for goods than gems.
Bill Ackman, Pershing Square
Gave a very concise, quick pitch on FDO, Family Dollar. A $54 stock, he sees 35-70% upside, primarily from improving operations and margins to make it comparable to Dollar General, a KKR owned competitor. For years, both DG and FDO operated at similar margins, similar top line growth rates. After KKR took over DG in July 2007, it began to outperform. Global sourcing of product, providing more private label goods (which are higher margin) would close the gap. EBIT margins at FDO are 7.6% v 10.5% at Dollar General. A buyer could pay $75+ for the stock, and upside could be as high as $95 a share from $54 today.
Mark Hart, Corriente Advisors
Perhaps the most eye-opening presentation of the day, Hart detailed why China is a credit fueled bubble that is very likely to pop. He noted several misconceptions about China: 1) it is not an economic miracle as most believe. Huge increases in Money Supply M2 have fueled credit growth that is unsustainable. M2 there is greater than the M2 of the US, despite the fact that the economy is only 40% as big as the US. Lending has increased by 70% since 2008 alone, and now is 125% of GDP. On top of that, NPL (non-performing loans) are reportedly DOWN since then. Not likely.
Also, look at prior Asian bubbles that blew up, notably Korea, Thailand and Malaysia. These countries' Fixed Asset Investments (FAI) as a % of GDP peaked between 40-45% leading up their busts in 1998. China today is spending 60% of GDP on infrastructure, or FAI. Local government borrowing is also out of control. Only 65% of local spending is affordable with cash inflows, the rest comes from asset sales.
Misconception #2: China's foreign currency reserves are savings. Truth is, there are corresponding liabilities. M2 = 12 TT (liabilities). Compare that to their FX reserves, and the ratio is only 25%. This ratio was 28% in prior Asian crises.
Misconception #3: The yuan will continue to appreciate. Hart believes that devaluation is actually the path of least resistance here. The only bull case for the yuan is capital flows into the country. But as soon as the bubble of infrastructure spending stops, these capital flows will also stop. The exit will lead to outflows and the yuan devaluing.
Trade: Buy 1 year at the money puts on RMB (yuan). Cost is 25bps, upside could be 100x your capital.
David Einhorn, Greenlight Capital
Always the best presenter, Einhorn outlined the bull case for Delta Lloyd, DL NA. Its a Dutch insurer trading at 15.50 Euro / Share with a 2.6BB market cap. Its trading at 6x EPS, with a 6% dividend yield. Its a life and pension company, 80% invested in Fixed Income, 20% equities. Its highly levered to the economy, and a 1% move in stocks equates to 20c in EPS. While TTM EPS is 3.75 (6x P/E), likely they'll do 2.25 EPS in 2010, as market returns decline.
Einhorn then revisited his pitch on Microsoft, MSFT. Five years ago he pitched MSFT at around $25/share, when the stock was doing $1.25 in EPS. Today, its doubled its EPS to $2.50, but the stock is flat. That is, P/E ratio has fallen from 15.6x to 7.3x. He outlined the misses that the company has suffered: social media, search, tablets, phone operating systems, application hosting, etc etc. Its success in office and enterprise software is overcome by its "miserable capital allocation plan." Case in point, trying to buy Yahoo! for $30+ a share. Only managers crazier than MSFT kept them from doing a terrible deal.
Then Einhorn began to systematically take apart Steve Ballmer. He compared him to Charlie Brown trying to kick a field goal with Lucy holding the football. He showed quotes of Ballmer back in 2008 saying things like, "Am I worried about the iPhone? No, maybe they'll get 2% or 3% market share." He listed all of the top senior managers who have left Microsoft under his Windows/Office only culture. Finally, he suggested change is needed, "someone else needs a turn at Quarterback." Great speech, I personally have tried to own MSFT, and not really made money. The cheap get cheaper, but at some point, there is a bottom.
Carl Icahn, Icahn Partners
I left just as Carl began to speak. He always rambles about how he shakes up boards, how his activism enhances shareholder value. He supposedly pitched his own stock, IEP after detailing why he gave back his investors money. The reason? He didnt want to be responsible for the losses that are likely in the market in a year or two. A stellar ending!
Friday, May 6, 2011
The Popping of the Silver Bubble: Still Too Early to Buy
Silver has been on a tear for the past year. If you haven't followed it, SLV, the underlying ETF, has traded from $19.50 an oz (or per share) as of just last August, to a high of $49.50 an oz just last Friday. Then, over the weekend, the bubble popped. In a mere four trading days this week, silver fell an astonishing 32%! Crushed. Today its rebounding a little and trading around $34 an oz. I find this subject endlessly fascinating, and apologize if this gets too long, but there is a conclusion you can skip to at the bottom.
HISTORY & THE HUNT BROTHERS
I admit to following the silver market longer than any other market. Being a kid in Texas in the early 1980s, I still remember when the Hunt brothers tried to corner the silver market. In 1979, the Hunt brothers, Herbert and Bunker (names of kids you would beat up in elementary school), began buying massive amounts of silver futures. They of course only needed a certain margin level to enter into the contracts (ie they levered to the hilt). Eventually they controlled, via futures and their own physical holdings, almost 1/3 of the entire world's deliverable supply of silver, some 200mm ounces.
Silver traded between $3 and 4 an ounce for most of the 1970s. However, by fall 1979, it had reached $11 an ounce. Markets were in a frenzy. Then, over the next few months, continued Hunt buying in conjunction with a Middle Eastern partner, drove silver to over $50 an ounce! Sometime during this ordeal, my older brother gleefully doled out his life savings ($750, he was in high school), and loaded up on silver coins. I think he paid $40 an ounce.
It was very shortly after when disaster struck: the COMEX, the futures exchange governing silver, changed the rules on silver margin requirements, forcing the Hunt brothers to stop buying. When they stopped, silver began to fall, and fall hard. When the Hunts received a $100mm margin call that they could not meet, silver went into a free fall. In its darkest day, silver fell by 50% on March 20, 1980. Nobody wanted anything to do with silver for a long time.
After the collapse, my brother never forgave himself, and silver continued to fall for the next 20 years. The Hunt brothers eventually went bankruptcy in 1988, losing some $1.7BB on their silver fiasco. Today in fact, Bunker Hunt lives just a few houses down from my parents in Dallas. (Its nice, but quite modest for someone who was at one time perhaps the wealthiest person on the planet). Personally I owned some physical silver starting in the late 1980s, and really loading up in the late 1990s in the $5-7 range. I missed all the Internet millions, but couldn't resist buying silver eagles.
As an aside, I highly recommend the book, Bryan Burrough's The Big Rich, which details the Hunts, the Murchisons, the Basses (via Sid Richardson), and the Cullen's family histories and how they came to their wealth. Hint, starts with O, ends in L. Great stuff.
SILVER SUPPLY & DEMAND
First of all, its not exactly clear, but a variety of estimates seem to converge on one level of total silver in the world today: 45BB ounces. That is, the world to date has produced 45BB ounces of silver give or take. What is more interesting however, is to examine silver supply and demand over the past 10 years. New production has been remarkably stable throughout the 2000s, averaging a steady 900mm ounces per year of new mined silver. That means we add about 2.5% to the world's supply of silver every year.
The general consensus on silver vs gold is the following: Gold has very little in the way of industrial uses, 50% of its production goes into jewelry, and the rest into world central banks and people's closets. Silver on the other hand, actually has numerous industrial uses. Of the 900mm or so ounces of silver mined per year, 700-800 gets used up every year in industrial applications, photographic applications, and in jewelry & silverware. However, last year silver took a big upturn in turns of total supply. While the world produced 920mm oz of silver in 2009, it jumped to 1,060mm ounces in 2010, up 15%. The net increase was naturally due to the price increases that we saw. More importantly, the net incremental demand came entirely from investment silver buyers. More on this in a sec.
Now, one problem I have with silver is that its demand is declining in 2 key categories: Photography and Silverware. Clearly digital photography has impacted silver demand, so much so that in the past 10 years, annual demand has fallen from 214mm oz to a mere 73mm oz in 2010. Same with silverware, with demand falling from 105mm ounces to 50mm ounces last year. People just don't buy silver wedding forks like they used to. That decline, combined nearly 200mm ounces per year, is a LOT of silver relative to supply of 1060mm ounces per year.
To make up for these losses in demand, the implied net investment demand, has risen dramatically in the past 2 years. The average annual investment demand was a mere 22mm ounces from 2000 to 2008. Then in 2009, I assume with QE1, investment demand jumped to 120mm ounces, up sixfold! Then in 2010 it was 178mm ounces! I have no way of knowing what this number will look like over the next 5 years, but based on trends for supply and demand, we will need to see investment demand AVERAGE over 195mm ounces per year, just to absorb new mined supply!
This demand can only come from new investment buyers. I honestly don't know if investment demand goes to 300mm ounces, or back to 22mm ounces per year. But HIGHER levels than 2010 are required now just to equalize supply & demand, and at significantly higher prices of silver. I doubt how much much higher demand can go.
Looked at another way, there are 425mm total ounces of physical silver via the 3 traded ETFs in the market. That number in 2 years has to almost double just to absorb new mining supplies. To put that in dollar terms, that implies $12BB in new buyers of silver (at 35/oz) over 2 years. Compare that the 2000-2008 time frame. Cumulative silver investment demand was a mere $1.7BB over that 8 year period. That is a massive increase.
CYCLICALITY
While the industrial applications category makes up about 50% of annual mined silver, it should be noted that this is heavily cyclical. Silver goes into hundreds of devices, including electrical components, catalytic converters in cars, etc. So in 2009, demand was especially hit hard during the recession. (demand fell 19%, from 493mm oz to 404mm in 2009). So, I think its important to realize that silver prices will likely be fairly correlated to the economic cycle, and cyclical stocks. The time to buy clearly is at the end of recessions, as likely it will get hit hard during a downturn. Silver has historically been more volatile than gold, I suspect this will continue. The problem with volatility is, when prices fall by 32%, people start to question whether they want to hold too much of it.
Most of all though, I think you want a silver investment thesis that doesn't depend on investment demand, but rather one that depends on increasing industrial demand, which is far more predictable.
THE GOLD-SILVER RATIO
To me, perhaps the best measure of whether or not silver is cheap is to look at the long term ratio of gold to silver prices. The chart below shows 1971-2009 what this ratio looks like. (prior periods were not terribly relevant given the Bretton Woods partial gold standard for the dollar).
If you drew a trend line on the chart, I think you would find that the average has been around 50. That is, gold typically trades 50x higher than silver. When gold is $1000/oz, silver historically has traded around $20 an ounce. You can see the silver price-spikes in the late 1979 time frame, when the Hunt brother tried to corner the market.
It wasn't long ago at all, however, 2009 to be exact, when the ratio got to as high as 86. That is, gold got pretty expensive, and silver was a great buy. What this chart fails to show however, is the spike in silver in just the last 18 months. The ratio today, even after a 32% fall, is an astonishingly low level of 41. That is still 20% below the historical average, meaning that silver is still perhaps 20% overvalued. History suggests buying silver when it hits a 65 or higher ratio, which today means I don't touch it until its around $22 an ounce. (I think a long GLD, short SLV trade probably is a good trade, but be careful).
SILVER COSTS
I tried in vain to figure out what it costs to mine silver on a per ounce basis. However, most silver mined is mined in conjunction with many other minerals, its hard to gauge. Generally, though, I found that anywhere from $6-12 per ounce in cash costs are what a miner pays to dig more silver out of the ground. Clearly, when Silver got to be above $15 in 2010, producers jacked up supply by quite a bit. There is a spigot here, and it got turned on full blast last year and likely this year too.
CONCLUSION
Don't touch silver now. I laughed on Tuesday when a guy on Seeking Alpha wrote an article saying he was buying more (at 42), and expected it to go to 62. You can see my comment there. Even today watching SLV, it initially rose almost 5% this morning, but has succumbed to more pressure. Its sits right now at $34, up less than 1%. I call this a dead cat bounce. (ie, even a dead cat will bounce a little). I will probably wait to buy more (physical or SLV, not sure) at $22 or lower. Fair value is probably the historical gold-silver ratio, which at 50 ratio implies around $29/oz. I don't know silver falls below $30, we might get one more run back to $40, but I think the bubble has popped, and we are due to continue correcting, or at least languishing where we are.
HISTORY & THE HUNT BROTHERS
I admit to following the silver market longer than any other market. Being a kid in Texas in the early 1980s, I still remember when the Hunt brothers tried to corner the silver market. In 1979, the Hunt brothers, Herbert and Bunker (names of kids you would beat up in elementary school), began buying massive amounts of silver futures. They of course only needed a certain margin level to enter into the contracts (ie they levered to the hilt). Eventually they controlled, via futures and their own physical holdings, almost 1/3 of the entire world's deliverable supply of silver, some 200mm ounces.
Silver traded between $3 and 4 an ounce for most of the 1970s. However, by fall 1979, it had reached $11 an ounce. Markets were in a frenzy. Then, over the next few months, continued Hunt buying in conjunction with a Middle Eastern partner, drove silver to over $50 an ounce! Sometime during this ordeal, my older brother gleefully doled out his life savings ($750, he was in high school), and loaded up on silver coins. I think he paid $40 an ounce.
It was very shortly after when disaster struck: the COMEX, the futures exchange governing silver, changed the rules on silver margin requirements, forcing the Hunt brothers to stop buying. When they stopped, silver began to fall, and fall hard. When the Hunts received a $100mm margin call that they could not meet, silver went into a free fall. In its darkest day, silver fell by 50% on March 20, 1980. Nobody wanted anything to do with silver for a long time.
After the collapse, my brother never forgave himself, and silver continued to fall for the next 20 years. The Hunt brothers eventually went bankruptcy in 1988, losing some $1.7BB on their silver fiasco. Today in fact, Bunker Hunt lives just a few houses down from my parents in Dallas. (Its nice, but quite modest for someone who was at one time perhaps the wealthiest person on the planet). Personally I owned some physical silver starting in the late 1980s, and really loading up in the late 1990s in the $5-7 range. I missed all the Internet millions, but couldn't resist buying silver eagles.
As an aside, I highly recommend the book, Bryan Burrough's The Big Rich, which details the Hunts, the Murchisons, the Basses (via Sid Richardson), and the Cullen's family histories and how they came to their wealth. Hint, starts with O, ends in L. Great stuff.
SILVER SUPPLY & DEMAND
First of all, its not exactly clear, but a variety of estimates seem to converge on one level of total silver in the world today: 45BB ounces. That is, the world to date has produced 45BB ounces of silver give or take. What is more interesting however, is to examine silver supply and demand over the past 10 years. New production has been remarkably stable throughout the 2000s, averaging a steady 900mm ounces per year of new mined silver. That means we add about 2.5% to the world's supply of silver every year.
The general consensus on silver vs gold is the following: Gold has very little in the way of industrial uses, 50% of its production goes into jewelry, and the rest into world central banks and people's closets. Silver on the other hand, actually has numerous industrial uses. Of the 900mm or so ounces of silver mined per year, 700-800 gets used up every year in industrial applications, photographic applications, and in jewelry & silverware. However, last year silver took a big upturn in turns of total supply. While the world produced 920mm oz of silver in 2009, it jumped to 1,060mm ounces in 2010, up 15%. The net increase was naturally due to the price increases that we saw. More importantly, the net incremental demand came entirely from investment silver buyers. More on this in a sec.
Now, one problem I have with silver is that its demand is declining in 2 key categories: Photography and Silverware. Clearly digital photography has impacted silver demand, so much so that in the past 10 years, annual demand has fallen from 214mm oz to a mere 73mm oz in 2010. Same with silverware, with demand falling from 105mm ounces to 50mm ounces last year. People just don't buy silver wedding forks like they used to. That decline, combined nearly 200mm ounces per year, is a LOT of silver relative to supply of 1060mm ounces per year.
To make up for these losses in demand, the implied net investment demand, has risen dramatically in the past 2 years. The average annual investment demand was a mere 22mm ounces from 2000 to 2008. Then in 2009, I assume with QE1, investment demand jumped to 120mm ounces, up sixfold! Then in 2010 it was 178mm ounces! I have no way of knowing what this number will look like over the next 5 years, but based on trends for supply and demand, we will need to see investment demand AVERAGE over 195mm ounces per year, just to absorb new mined supply!
This demand can only come from new investment buyers. I honestly don't know if investment demand goes to 300mm ounces, or back to 22mm ounces per year. But HIGHER levels than 2010 are required now just to equalize supply & demand, and at significantly higher prices of silver. I doubt how much much higher demand can go.
Looked at another way, there are 425mm total ounces of physical silver via the 3 traded ETFs in the market. That number in 2 years has to almost double just to absorb new mining supplies. To put that in dollar terms, that implies $12BB in new buyers of silver (at 35/oz) over 2 years. Compare that the 2000-2008 time frame. Cumulative silver investment demand was a mere $1.7BB over that 8 year period. That is a massive increase.
CYCLICALITY
While the industrial applications category makes up about 50% of annual mined silver, it should be noted that this is heavily cyclical. Silver goes into hundreds of devices, including electrical components, catalytic converters in cars, etc. So in 2009, demand was especially hit hard during the recession. (demand fell 19%, from 493mm oz to 404mm in 2009). So, I think its important to realize that silver prices will likely be fairly correlated to the economic cycle, and cyclical stocks. The time to buy clearly is at the end of recessions, as likely it will get hit hard during a downturn. Silver has historically been more volatile than gold, I suspect this will continue. The problem with volatility is, when prices fall by 32%, people start to question whether they want to hold too much of it.
Most of all though, I think you want a silver investment thesis that doesn't depend on investment demand, but rather one that depends on increasing industrial demand, which is far more predictable.
THE GOLD-SILVER RATIO
To me, perhaps the best measure of whether or not silver is cheap is to look at the long term ratio of gold to silver prices. The chart below shows 1971-2009 what this ratio looks like. (prior periods were not terribly relevant given the Bretton Woods partial gold standard for the dollar).
If you drew a trend line on the chart, I think you would find that the average has been around 50. That is, gold typically trades 50x higher than silver. When gold is $1000/oz, silver historically has traded around $20 an ounce. You can see the silver price-spikes in the late 1979 time frame, when the Hunt brother tried to corner the market.
It wasn't long ago at all, however, 2009 to be exact, when the ratio got to as high as 86. That is, gold got pretty expensive, and silver was a great buy. What this chart fails to show however, is the spike in silver in just the last 18 months. The ratio today, even after a 32% fall, is an astonishingly low level of 41. That is still 20% below the historical average, meaning that silver is still perhaps 20% overvalued. History suggests buying silver when it hits a 65 or higher ratio, which today means I don't touch it until its around $22 an ounce. (I think a long GLD, short SLV trade probably is a good trade, but be careful).
SILVER COSTS
I tried in vain to figure out what it costs to mine silver on a per ounce basis. However, most silver mined is mined in conjunction with many other minerals, its hard to gauge. Generally, though, I found that anywhere from $6-12 per ounce in cash costs are what a miner pays to dig more silver out of the ground. Clearly, when Silver got to be above $15 in 2010, producers jacked up supply by quite a bit. There is a spigot here, and it got turned on full blast last year and likely this year too.
CONCLUSION
Don't touch silver now. I laughed on Tuesday when a guy on Seeking Alpha wrote an article saying he was buying more (at 42), and expected it to go to 62. You can see my comment there. Even today watching SLV, it initially rose almost 5% this morning, but has succumbed to more pressure. Its sits right now at $34, up less than 1%. I call this a dead cat bounce. (ie, even a dead cat will bounce a little). I will probably wait to buy more (physical or SLV, not sure) at $22 or lower. Fair value is probably the historical gold-silver ratio, which at 50 ratio implies around $29/oz. I don't know silver falls below $30, we might get one more run back to $40, but I think the bubble has popped, and we are due to continue correcting, or at least languishing where we are.
Wednesday, January 19, 2011
Some Thoughts on Apple Stock AAPL
If you read this blog, then you have probably seen me allude to the fact that everyone should own Apple in their PA. There has been a bit of news on the stock in the past 2 days, and I thought it would be helpful to revisit the name.
First of all, on Monday Apple announced that CEO Steve Jobs is taking a leave of absence for unspecified medical reasons. Further, there was no mention of how long he would be gone. Steve Jobs, who founded Apple in 1976, is considered by many to be the best product development manager ever. CEO of the decade, you name it, he single-handedly poured his life into designing their computers, the iPod, the iPhone, etc etc. He could be considered the most important CEO to any company out there. Without Jobs, there is great risk that product development languishes. And the world of mobile computing is notoriously cut throat. Motorola was the king of mobile phones in the early to mid 1990s, and eventually lost out to better designs. That stock has only gone down in the past 15 years since it peaked.
So, the question is, has AAPL peaked? The stock has rocketed from $75 / share 5 years ago, to $345 today. Jobs' job may be on the line, and competitors like the new Microsoft phone and Android are actually pretty decent. Can Apple continue to grow?
The good news is, the company reported earnings yesterday. I don't think it was a coincidence that they reported good quarterly earnings the day after Jobs took his medical leave. They are managing the newsflow. This is also the 3rd time in 5 years that Steve Jobs has taken a medical leave. None of those episodes were explained either. I find it a little irresponsible of the company not to better explain the management situation, but Apple respects his privacy more than the shareholders' right to know. Enough said.
The first indicent, it turned out Jobs had a pancreatic tumor, and he recovered and was pronounced cancer free. The second time, he told the world after the fact that he had a liver transplant. That was 2 years ago, and he took 6 months off. His COO, Tim Cook, handled the day to day management of the company. Tim Cook is considered an apt manager though, and I have read more and more that Wall Street is comfortable with Cook running the company during Jobs' absence.
So, the question is now, is the stock cheap? Does it discount the risk to losing Jobs? Well, AAPL reported December earnings yesterday after the market closed, and by almost any metric, they were phenomenal. Sales were up 71%. EPS was up 72%. Sales of iPhones were up 88%. iPads generated 4.6BB in sales in the quarter on 7.3mm units sold. They had zero iPads a year ago so you can't measure growth. And so on.
So, in the calender year 2010, Apple generated $76BB in total sales, vs only $46BB the year before. iPhones and iPads and applications and iTune downloads continue to grow at very high growth rates. I asked myself though if growth has peaked. It cannot accelerate, although in the last 5 quarters, EPS growth has been 50%, 89%, 78%, 70%, 72%. Strong. And revenue growth amazingly appears to be accelerating, growing in the last 5 quarters: 32%, 49%, 61%, 67% and 71%. Wow.
So, what is the market saying about Apple. Well based on its Q4 earnings, the company first of all has $59BB in cash. That's $64/share. So I am going to subtract that from the share price and calculate what the business generates in earnings. At 346/share, less $64 leaves me buying the business at $282 per share. And on a TTM basis, they did $18.10 in EPS (excluding interest income which was nil). That means I am paying 15.6x earnings. Compared to the S&P, the market essentially trades at a 15.2x P/E ratio. That is a very negligible premium compared to the market. Furthermore, GS calculates that AAPL has traded on average at 23x earnings over the past decade, much higher than today. I dont quite get it honestly. Perhaps it's just a case of the stock not keeping up with earnings in a volatile world.
Clearly it's also that the law of large numbers has to hamper growth here. But if S&P earnings are expected to grow by 9% in 2011, shouldn't Apple still trade at a much better multiple? Why does it languish at a market multiple when the numbers suggest that AAPL will grow EPS by 40-50% in 2011?
Finally, I did some math to figure out if there really is growth left. Based on guidance for the next quarter, annual revenue through March 2011 will be $85BB. Thats pretty much in the bag. Now everyone knows that finally the iPhone is coming to Verizon. That date is February 10th. Based on some surveys I saw online, an astonishing 26% of Verizon users expect the switch to an iPhone. Count me in that category. We plan to be dialing on an iPhone on the 10th. Further, there are 93mm Verizon wireless subscribers. That means you have a potential of 24mm unit sales of iPhones over the next say 2 years as contracts roll off. Now you could argue that Verizon sales will cannabilize AT&T sales, but really of the 9omm total iPhones sold worldwide, about 15-20mm are US AT&T models, I estimate. 80% of iPhone sales are international.
I have read that VZ expects to sell between 7-13mm iPhones in the first year. I think 10mm is a reasonable number. At $625 a pop, that is 6.25BB more in revenue in 2011 just from the VZ iPhone. We didnt count the AT&T users who plan to switch to Verizon because the network there is notoriously bad. So, if Apple has $85BB in sales pretty much in the bag, and you throw in another 6.25BB from the VZ iPhone, and add a full year of the iPad (add another $3BB), then that gets you to $94BB of annual sales. Translating that to EPS gets me in the $22-23 per share range. That is awfully close to where the street is forecasting EPS for 2011 too.
And then there is China. They only did $3BB of their sales to China last year. The US generated $20BB in sales last year on a $14 Trillion economy. China's economy was $5 Trillion, so it seems there is much room for further growth. This is heavily generalized but, in fact, in December the quarterly numbers show that revenue was up 175% in Asia Pacific compared to the year before. Its just starting to take off there.
Finally their quarterly numbers were hampered by production backlogs. They cannot make enough iPhones and iPads. It appears that the iPad shortages have been resolved, and they now plan to add 15 more countries this month to their existing list of 46 countries where the iPad is available. More sales growth.
I almost hate to agree with the sellside on a valuation. But I think this stock is worth 15-17x its 2011 EPS number. Figure that they'll build another $12 per share in cash, that means you will have 76/share in pure cash, and a business doing between 22-24 in EPS. You are in essence paying $269/share for a business that will do $22 per share in earnings. That is 12x forward earnings! Note that RIMM trades at 10x 2011 earnings, and given that 40% of Apple iPhones are sold to enterprises, that could seriously dampen Blackberry sales.
I am not surprised that GS and JPM just raised their forecast for the stock. They peg value at $450/share, which to me is not crazy. 375/22 in EPS implies that the stock can get to a 17x multiple by year end, still below its historical average. That is 30% upside.
As a final gut check, I always focus on cash earnings. Here I took CF from operations, and subtracted capex. That is REAL cash flow, unmanipulated for the most part. (D&A, depreciation and amortization is the biggest driver of manipulated earnings along with "non-recurring items"). Anyway, here is what I get per year in cash vs GAAP earnings:
Cash EPS GAAP EPS
2008: $9.20 $6.78
2009: $9.94 $9.08
2010: $17.25 $15.15
As you can see, Cash EPS is higher every year. I haven't done the forensic accounting to figure out why, but I note that they deferred a lot of revenue (ie the cash comes in, but not booked until as late as possible). The balance sheet shows almost $4BB of deferred revenue as of the end of September. Probably also some inventory management going on. Doesn't really matter. But this also brings up the point of returns on equity (ROEs). ROEs were around 29% last year, but the company's ROA, if you take out the cash would be an astronomical 58%. And in fact if you used CASH earnings, the number goes even higher. Very impressive. You cannot find a better, cleaner company from a balance sheet and reported earnings perspective.
Now, the negatives to the stock should also be pointed out. I have no idea what they do for growth beyond 2011. Steve Jobs may not come back this time, let's hope he does. But if his health has finally caught up with him, then there is real product development risk. The established base of devices is high, but then always subject to declining market share and cyclicality. Near term the quarter benefitted from a lower tax rate of 25% from 29%. That could go back the other way again impacting earnings.
And finally, sentiment is very high for Apple. I assume you have heard of a short squeeze before, but there is also such a thing as a long squeeze. That is, NOBODY is short apple stock. The short ratio is 0.6%, or about 6.8mm shares short out of 915mm publicly traded. That number is also down from almost 20mm shares short last February. You need a good short base to generate some buy orders when the stock falls. If not, you need to find new buyers of the stock to support it. Long holders keep pushing it down with no support. Feels like its happening now actually. If the short interest ever gets back to 20mm shares again, then probably that would mark a bottom.
So, do you buy here? I don't really know. I already own it, I'll probably look to buy more if it falls 5% from here, which is around $320-325 a share. One study showed that tech companies that get new CEOs, fall on average 10% in the 12 months following the change in management. If Jobs has to fully resign, then history suggests this stock falls to $300 a share. Could be worse though given his importance to the company. If it works and he comes back to work in a few months, then I think $450 is a reasonable upside in 9-12 months.
First of all, on Monday Apple announced that CEO Steve Jobs is taking a leave of absence for unspecified medical reasons. Further, there was no mention of how long he would be gone. Steve Jobs, who founded Apple in 1976, is considered by many to be the best product development manager ever. CEO of the decade, you name it, he single-handedly poured his life into designing their computers, the iPod, the iPhone, etc etc. He could be considered the most important CEO to any company out there. Without Jobs, there is great risk that product development languishes. And the world of mobile computing is notoriously cut throat. Motorola was the king of mobile phones in the early to mid 1990s, and eventually lost out to better designs. That stock has only gone down in the past 15 years since it peaked.
So, the question is, has AAPL peaked? The stock has rocketed from $75 / share 5 years ago, to $345 today. Jobs' job may be on the line, and competitors like the new Microsoft phone and Android are actually pretty decent. Can Apple continue to grow?
The good news is, the company reported earnings yesterday. I don't think it was a coincidence that they reported good quarterly earnings the day after Jobs took his medical leave. They are managing the newsflow. This is also the 3rd time in 5 years that Steve Jobs has taken a medical leave. None of those episodes were explained either. I find it a little irresponsible of the company not to better explain the management situation, but Apple respects his privacy more than the shareholders' right to know. Enough said.
The first indicent, it turned out Jobs had a pancreatic tumor, and he recovered and was pronounced cancer free. The second time, he told the world after the fact that he had a liver transplant. That was 2 years ago, and he took 6 months off. His COO, Tim Cook, handled the day to day management of the company. Tim Cook is considered an apt manager though, and I have read more and more that Wall Street is comfortable with Cook running the company during Jobs' absence.
So, the question is now, is the stock cheap? Does it discount the risk to losing Jobs? Well, AAPL reported December earnings yesterday after the market closed, and by almost any metric, they were phenomenal. Sales were up 71%. EPS was up 72%. Sales of iPhones were up 88%. iPads generated 4.6BB in sales in the quarter on 7.3mm units sold. They had zero iPads a year ago so you can't measure growth. And so on.
So, in the calender year 2010, Apple generated $76BB in total sales, vs only $46BB the year before. iPhones and iPads and applications and iTune downloads continue to grow at very high growth rates. I asked myself though if growth has peaked. It cannot accelerate, although in the last 5 quarters, EPS growth has been 50%, 89%, 78%, 70%, 72%. Strong. And revenue growth amazingly appears to be accelerating, growing in the last 5 quarters: 32%, 49%, 61%, 67% and 71%. Wow.
So, what is the market saying about Apple. Well based on its Q4 earnings, the company first of all has $59BB in cash. That's $64/share. So I am going to subtract that from the share price and calculate what the business generates in earnings. At 346/share, less $64 leaves me buying the business at $282 per share. And on a TTM basis, they did $18.10 in EPS (excluding interest income which was nil). That means I am paying 15.6x earnings. Compared to the S&P, the market essentially trades at a 15.2x P/E ratio. That is a very negligible premium compared to the market. Furthermore, GS calculates that AAPL has traded on average at 23x earnings over the past decade, much higher than today. I dont quite get it honestly. Perhaps it's just a case of the stock not keeping up with earnings in a volatile world.
Clearly it's also that the law of large numbers has to hamper growth here. But if S&P earnings are expected to grow by 9% in 2011, shouldn't Apple still trade at a much better multiple? Why does it languish at a market multiple when the numbers suggest that AAPL will grow EPS by 40-50% in 2011?
Finally, I did some math to figure out if there really is growth left. Based on guidance for the next quarter, annual revenue through March 2011 will be $85BB. Thats pretty much in the bag. Now everyone knows that finally the iPhone is coming to Verizon. That date is February 10th. Based on some surveys I saw online, an astonishing 26% of Verizon users expect the switch to an iPhone. Count me in that category. We plan to be dialing on an iPhone on the 10th. Further, there are 93mm Verizon wireless subscribers. That means you have a potential of 24mm unit sales of iPhones over the next say 2 years as contracts roll off. Now you could argue that Verizon sales will cannabilize AT&T sales, but really of the 9omm total iPhones sold worldwide, about 15-20mm are US AT&T models, I estimate. 80% of iPhone sales are international.
I have read that VZ expects to sell between 7-13mm iPhones in the first year. I think 10mm is a reasonable number. At $625 a pop, that is 6.25BB more in revenue in 2011 just from the VZ iPhone. We didnt count the AT&T users who plan to switch to Verizon because the network there is notoriously bad. So, if Apple has $85BB in sales pretty much in the bag, and you throw in another 6.25BB from the VZ iPhone, and add a full year of the iPad (add another $3BB), then that gets you to $94BB of annual sales. Translating that to EPS gets me in the $22-23 per share range. That is awfully close to where the street is forecasting EPS for 2011 too.
And then there is China. They only did $3BB of their sales to China last year. The US generated $20BB in sales last year on a $14 Trillion economy. China's economy was $5 Trillion, so it seems there is much room for further growth. This is heavily generalized but, in fact, in December the quarterly numbers show that revenue was up 175% in Asia Pacific compared to the year before. Its just starting to take off there.
Finally their quarterly numbers were hampered by production backlogs. They cannot make enough iPhones and iPads. It appears that the iPad shortages have been resolved, and they now plan to add 15 more countries this month to their existing list of 46 countries where the iPad is available. More sales growth.
I almost hate to agree with the sellside on a valuation. But I think this stock is worth 15-17x its 2011 EPS number. Figure that they'll build another $12 per share in cash, that means you will have 76/share in pure cash, and a business doing between 22-24 in EPS. You are in essence paying $269/share for a business that will do $22 per share in earnings. That is 12x forward earnings! Note that RIMM trades at 10x 2011 earnings, and given that 40% of Apple iPhones are sold to enterprises, that could seriously dampen Blackberry sales.
I am not surprised that GS and JPM just raised their forecast for the stock. They peg value at $450/share, which to me is not crazy. 375/22 in EPS implies that the stock can get to a 17x multiple by year end, still below its historical average. That is 30% upside.
As a final gut check, I always focus on cash earnings. Here I took CF from operations, and subtracted capex. That is REAL cash flow, unmanipulated for the most part. (D&A, depreciation and amortization is the biggest driver of manipulated earnings along with "non-recurring items"). Anyway, here is what I get per year in cash vs GAAP earnings:
Cash EPS GAAP EPS
2008: $9.20 $6.78
2009: $9.94 $9.08
2010: $17.25 $15.15
As you can see, Cash EPS is higher every year. I haven't done the forensic accounting to figure out why, but I note that they deferred a lot of revenue (ie the cash comes in, but not booked until as late as possible). The balance sheet shows almost $4BB of deferred revenue as of the end of September. Probably also some inventory management going on. Doesn't really matter. But this also brings up the point of returns on equity (ROEs). ROEs were around 29% last year, but the company's ROA, if you take out the cash would be an astronomical 58%. And in fact if you used CASH earnings, the number goes even higher. Very impressive. You cannot find a better, cleaner company from a balance sheet and reported earnings perspective.
Now, the negatives to the stock should also be pointed out. I have no idea what they do for growth beyond 2011. Steve Jobs may not come back this time, let's hope he does. But if his health has finally caught up with him, then there is real product development risk. The established base of devices is high, but then always subject to declining market share and cyclicality. Near term the quarter benefitted from a lower tax rate of 25% from 29%. That could go back the other way again impacting earnings.
And finally, sentiment is very high for Apple. I assume you have heard of a short squeeze before, but there is also such a thing as a long squeeze. That is, NOBODY is short apple stock. The short ratio is 0.6%, or about 6.8mm shares short out of 915mm publicly traded. That number is also down from almost 20mm shares short last February. You need a good short base to generate some buy orders when the stock falls. If not, you need to find new buyers of the stock to support it. Long holders keep pushing it down with no support. Feels like its happening now actually. If the short interest ever gets back to 20mm shares again, then probably that would mark a bottom.
So, do you buy here? I don't really know. I already own it, I'll probably look to buy more if it falls 5% from here, which is around $320-325 a share. One study showed that tech companies that get new CEOs, fall on average 10% in the 12 months following the change in management. If Jobs has to fully resign, then history suggests this stock falls to $300 a share. Could be worse though given his importance to the company. If it works and he comes back to work in a few months, then I think $450 is a reasonable upside in 9-12 months.
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