The Stalwart

Analysts Anonymous - My Take on What's Happening

You can take the analyst out of the brokerage, but you can't take the brokerage out of the analyst. What's happening now, this Stalwart's take.

...Obama's economic plan could include a large dose of tax cuts, perhaps totalling $300bn, rather than simply pumping out purely government expenditures. Which is probably good thing and should make many republicans happy. 

Still, US steel companies see no reason to sit back and relax. Having seen the success of the automakers, US steelmakers are now clamoring for government support despite recent boom times. 

As an aftershock from the commodities boom, some shipper groups are clamoring for re-regulation of US railroads, complaining that recent price hikes were unfair. Rail is still probably a better deal than trucks, given customers are taking the price hikes, though lower oil could change this. US railroads were deregulated around 1980 after years of horrible performance. Now they finally have had the ability to modernize and create one of the most efficient rail shipping infrastructures in the world. Hopefully the twisted lesson learned from all this won't be to go back to the way it was.

In terms of economic indicators, the US manufacturing index fell to a 28 year low in December, and if the December rate were to persist for a full year, US GDP would drop 2.7%. Lets hope thats not quite the scenario which plays out. China isn't doing so well either, where manufacturing output fell (yes, economic indicators can actually go negative in high growth China) for the third straight month. 

US auto sales in 2008 fell nearly 20% vs. 2007. And thus oddly enough... Japan could be experiencing a sort of pyrrhic victory since just as autos become the country's #1 export, we hit one of the worst auto slumps in recent memory. Cars seem so 20th century these days.

In Semiconductors, semi sales fell 10% YoT in November with memory hit especially hard. Probably related, there are reports of a spreading consumer electronics inventory glut. Music sales fell in 2008 for the 7th time in 8 years. Perhaps the CD will be one of this recessions fatalities.

In the deal space. Pfizer's CEO has recently said that he is open to acquisitions. Let the speculation commence (continue?). Pharma is one place dealmaking isn't on life support, as buying companies these days is likely cheaper, and faster, than in-house R&D. Also, interesting article in regards to all the stakeholders DOW's CEO is struggling to appease. Rohm & Haas, to complete the deal, shareholders, banks who are iffy on DOW's financial post a potential ROH deal. The Kuwaitis, though they might now be out of the picture after canceling their JV.

Please bear with this recovering analyst.

(Vincent)

An Experimental Post, US Refiners Still Price-in Industry Strength

I admit that this is a rather experimental post. I have done some work recently looking at valuations on US independent refiners and have reached some conclusions, one being that current share prices, despite their substantial declines in 2008, still price-in a historically strong industry environment going forward. Thus they are not priced for hard times as some might believe.  The four companies I look at, Valero (VLO), Tesoro (TSO), Frontier (FTO), and Holly (HOC), are actually still more expensive in terms of capacity valuation than they were at their own share price highs of 1998-2003, at least by my analysis.

I also believe that the strongest ideas are formed via sharing and confrontation. 

I have thus attached a rather detailed PDF to this post, which looks at calculated historical EV/Capacity valuatons for four US refiners. Perhaps something similar has already been said elsewhere, but I have a feeling that likely not using the same perspective, and thus I hope this piece adds some value. 

Rather than imply an outright Buy or Sell opinion, it rather aims to say merely "US refiners aren't priced for hard times, they still price-in a historically strong industry environment". It is just meant to add one piece to a large puzzle. Anyhow, here is the link for any interested.

Download Ind Refiners EV.Cap 

Let me caution that I in no way guarantee any of its contents, and this is purely a personal opinion being presented which could change at any time. Everyone should do their own due diligence. Some estimates are used, such as adding near term future capacity additions to last reported capacity. Also, while I currently don't have any personal exposure to these shares, I could have exposure to them at any time without notice. 

Other than that, well hopefully enjoy!

(Vincent)

Post-Panic, Market Inefficiencies in the Crannies

If one thing this financial crisis has exposed, it is that markets aren't as efficiently priced as half of modern financial theory presupposes. I am not referring to the housing crisis, where much has already been said.

Rather, I am referring to stock, bond, and derivative markets for a wide range of companies. Market dislocation has resulted in some peculiar inefficiencies crossing this Stalwart's eye, some of which are very tangible. 

For stocks alone, its always pretty hard to reject efficiency in pricing since there are a lot of fuzzy variables. But when you look across the capital structure of a single company and compare prices for different securities related to the same underlying, this is where the recent market dislocations have exposed clear ineffiencies in my opinion.

One example this Stalwart has seen has been an issue of convertible bonds, with equal seniority and credit rating to plain vanilla bonds for the same company, providing higher yields to maturity than their plain vanilla bond relatives. They also had shorter maturities, plus provided an option (though far out of the money due to the underlying stock's collapse) as an added bonus as well.

Why the yield difference? Well it has at least been proposed that a lot of convertible bond funds have ceased to exist or reduced their activity due to their previous reliance on leverage. Thus removing a lot of buyers. And standard bond funds usually won't buy converts as a matter of investment mandate.

A second example has been again a small issue of a convertible bond, but one right near-the-money with its conversion price vs. the current stock price. This means its almost the same as buying the stock. The kicker was that the bond was puttable at par two years forward, with a slightly negative yield to put. The company was net cash and a well established leader in what it does, thus payback of the bond within two years is highly certain, if not nearly absolute.

This basically means that the risk reward was equal to the stock on the upside, but with only a slight negative loss should the stock fall and investors are forced to put the bonds (easily done by the net cash company)

Some stocks have also become compelling vs. their related options, as option premiums for some stocks hit substantial percentages of their underlying, making their downside risk profile (losing your premium) quite similar to simply buying the stock. And vice versa. 

I'm in no way saying things are easy, all situations carry risks, some of which are hard to gauge. But at the very least there are securities out there which appear clearly better or worse plays on the same underlying. And market dislocations and panic have made this more apparent than perhaps in the recent past.

(Vincent)

Kick'em While They're Down

John Paulson, of hedge fund firm Paulson & Company, in recent investor communications has lambasted his competitors for blocking investor redemption requests, something his firm has not done. His firm has actually fared well in 2008, thus hasn't been pressured by substantial redemptions.

“We think it’s a mistake for managers to use gates and other tools to limit investor access to their funds,” Mr. Paulson wrote, according to Bloomberg. “While we recognize the difficulties of the current environment, we think it is a manager’s responsibility to raise liquidity to meet the redemption needs of their investors.”

Of course, Mr. Paulson’s funds are showing profits this year, even as many of his rivals’ funds are flailing, and his investors are unlikely to be pounding the door for their money back. In November, Mr. Paulson’s firm, Paulson & Company, held an opulent dinner in New York to celebrate his funds’ returns and outline his strategy for the coming year.

In his recent investor letter, Mr. Paulson also said that he was “especially surprised” by managers who blocked or limited withdrawals in cases when the requests accounted for a quarter or less of assets under management, Bloomberg said, and where “the managers have the cash and one of the stated reasons for restricting withdrawals is so the manager can continue to invest in new opportunities.”

Winning is hard. Winning gracefully even harder.

How Many Dr. Doom's Are There?

Heny Kaufman, AKA Dr. Doom, lost substantial money based on the Madoff fiasco. The Madoff losses are a tragedy for those involves, but what struck me in this article was that I was unaware of Mr. Kaufman until now, and his Dr. Doom status. This now brings the total number of Dr. Doom's to four in my book, which has me wondering... how many Dr. Doom's are there?

Henry Kaufman, the former Salomon Brothers chief economist whose bearish views decades ago earned him the nickname "Dr. Doom," lost several million dollars with Bernard Madoff, making him one of the most prominent Wall Street figures to emerge as a victim of the alleged Ponzi scheme.

This is because, to my knowledge, in addition to Mr. Kaufamn, there is of course Dr. Doom Marc Faber, the Swiss Contrarian in Asia before it was popular, and Nouriel Roubini, who I would say plays the part of Dr. Doom best if you've ever seen a video of him speaking. He probably is the most recent person to earn the monicker when his years-old predictions seemed to finally come through in 2007, though perhaps not for the exact reasons he initially described. 

And finally, there is Stephen Roach, who is has long branded himself as one of the key bears on Wall Street, and who despite a recent embarassing about-face right before things collapsed, can still hold claim to being Dr. Doom due to sheer inertia.

The funny thing is that all of these very intelligent individuals nevertheless likely had very different explanations of the problems which the global economy faced and how things would unravel, yet all can now capture a share of the Dr. Doom glory. They do this by just being long known as a bear, by relating todays problems somehow back to their own original premises, or even just ignoring their original premises, not looking back, and describing and disparaging the financial problems which we now know.

Interesting lessons to be learned for aspiring pundits, though the Dr. Doom space now seems rather crowded. Probably best to now swing for the other extreme and build yourself as a well known optimist, though perhaps despite a tough market there is still an oversupply of such outlooks. Well, at the very least I'm pretty optimistic long term for the US economy at least, so perhaps its time to start claiming the space.

Organic Vegetable Monopolies & Snack Food Vitamins

In regards to the Whole Foods/ Wild Oats merger. Won't burden you with a tirade here. But this is hilarious:

FTC lawyer Matthew Reilly told Friedman he could impose a range of remedies, and that because a lack of competition in the premium natural and organic groceries is harming consumers, the agency wants to stop further integration and impose a hold separate for the Wild Oats assets that its new owner hasn't absorbed.

Hard to see how premium natural and organic groceries are some sort of opportunity for an invincible monopoly. I got another good one, two in the same day. In regards to Diet Coke Plus:

The FDA said the soft drink, Diet Coke Plus, doesn't contain enough nutrients to qualify for use of the word "plus." Foods may use that name only if they contain at least 10% more of the reference daily intake or daily reference value of a nutrient than a similar product. The FDA also invoked a longstanding rule under which it "does not consider it appropriate" to fortify snack foods such as carbonated beverages.

I'm actually a bit moderate and not too perturbed by the requirement for 10% additional vitamins in order to qualify for "Plus". But nevertheless, I had a good laugh whereby a company is told not to add vitamins and minerals to a product. I think diet coke with vitamins sounds like a pretty good drink. What's another good idea, but one I haven't seen yet? Coffee with vitamins and minerals. Hopefully that is allowed. Would make for a pretty good start to the day. Anyhow.

(Vincent)

Live! From Austin

I'd been meaning to mention this sooner here, but I'm currently on my annual 2-week sojourn to Austin, TX. I have my fair slew of friends here from college days, but I always like meeting new people especially if you read this blog, etc.

Ping me jnathan@gmail.com if you want to meet up.

GM Could Go to Zero, Chrysler Even More Likely. Ahh... So We Do Have a Non-Govt Mechanism for Restructuring Companies

Yes we know. We could have been more succinct with our title. Nevertheless, one of the top US business stories yesterday involved a Credit Suisse analyst predicting that GM could go to zero in its restructuring process. Which would mean that over $2bn of equity value could be wiped out as debt restructuring could lead to current equity holders being diluted to oblivion. Of course in return for equity stakes, creditors would agree to haircuts on their principal. 

Which would reduce the debt burden and help restructure GM's business for survival... at the expense of current shareholders and creditors. Wait a second. So there is a non-government method to save the automakers. And taxpayers don't need to foot the bill? Creditors and Shareholders foot the bill and provide the concessions in order to salvage the remaining value of the company? Amazing this system we have.

Wonder why our system's basic functioning eludes most who argue for a government auto bailout as if its the only choice.

Shareholders get wiped out, as they deserve to be if indeed GM is worth less than its debt, creditors convert their debt to new equity, and there you have it GM can reduce its onerous debt burden. So where's the problem?

Ah yes, the UAW. They refused to have pay rates competitive with other US autoworkers in 2009. A bankruptcy and associated restructuring as described above would force them to negotiate contracts on similar terms to most workers in the USA. Thus their fear of bankruptcy and the widespread promotion of the nonsensical idea that "bankruptcy is not an option". Not an option for whom?

Bankruptcy doesn't usually mean the death of a company, nor the firing of all its workers. Somehow these basic points, plus the point that UAW members have benefits well above the average American, have been obscured in order to persuade Americans that a government bailout is needed. Hopefully understanding why GM shares could go to zero can help illuminate the fact that we already have a system for restructuring distressed companies and making them viable gain - bankruptcy.

(Vincent)

Coase On Beet Greens

 Hey y'all, it's Joe here... haven't posted in a while, but alas that's happened from time to time before.

Anyway, I wanted to throw out something I've been thinking of. I feel like there's a real breakdown of the Coase Theorem when it comes to the vegetable beets. See, most people like to eat beets and they throw away the greens. I on the other hand, don't like beets, but prefer the greens. In fact they may the most delicious of all greens -- and it faces some pretty stiff competition among kale and collards.

It's problematic from an economic standpoint that greens that most people just toss the greens. I'd LOVE those greens. There should be a business collecting discarded greens and then selling them to people, but it's not obvious to me what the model is.

But this is such a big, sad waste that there has to be one. Just can't figure it out.

CEG Bids a Hasty Au Revoir to Buffet, Without Shareholder Approval

In what has been an action-packed M&A arb drama, Constellation Energy (CEG) has entered a defininitive agreement with France's EDF group to sell a 50% stake in its nuclear generation and operation business, bidding a hasty au revoir to Buffet's MidAmerican Holdings. 

Constellation Energy Group said Wednesday that it will sell a 49.9% stake in its fleet of five nuclear reactors and other holdings to Electricité de France SA for $4.5 billion, derailing the pending $4.7 billion takeover by Warren Buffett's MidAmerican Energy Holdings.

Nevertheless, CEG and MidAmerican parted on good terms and Buffet still made a handsome return given termination fees, an appreciated stake in CEG and related other cash payment requirements. Not a bad way to lose:

For its part, MidAmerican will receive a hefty termination package. The deal calls for MidAmerican to get a $175 million termination fee. Additionally, preferred shares issued to its wholly owned MEHC Investment Inc. unit will convert, giving MEHC a $1 billion note at 14% interest and about 20 million shares of Constellation stock, representing about 10% of outstanding shares; and roughly $418 million in cash.

But the real interesting point I feel is that it seems CEG wasn't required to obtain shareholder approval for this deal. I am no expert on these kinds of details, but I would have assumed that a shareholder vote was required. It appears not to be the case as shown in this excerpt from the CEG press release below.

The companies expect to receive the necessary regulatory approvals for the acquisition of EDF Development Inc.'s interest in Constellation Energy's nuclear generation and operation business and close the transaction within six to nine months. The companies will work closely with Maryland regulators to make them fully informed of the transaction's details. Approval from Constellation Energy's shareholders is not required.

Ok well I guess that's life in the big city. Shareholders were nevertheless likely to be overall positive on the deal given previous opposition to the MidAmerican $26.5 bid as being too low. And not to imply any wrong-doing at all here, but it is still surprising, at least to this Stalwart, that such a massive change in course did not requite shareholder approval. If someone wishes to clarify the situation or explain their take, then please feel free to do so.

(Vincent)