Saturday, October 1, 2016 0 comments

Purchase (Liquidation): Khan Resources (KRI)

Likely return on this is very small but thought it was worth taking a position...

I was reading this article on Bloomberg on Mongolia and it mentioned the mining license dispute with Khan Resources (CSE: KRI) that was finally settled by the Mongolian government. Now that the company has received the settlement, it will be liquidating itself and distributing its holdings to shareholders. I was evaluating it and following it for about a month before taking the plunge now.

Based on some liquidation value calculations I did a while back--basically discounting assets and applying estimates of liabilities for liquidation--I arrived at a liquidation value of C$0.93 (calculation at bottom but final payment likely much lower). However, the company finally issued a press release on Sept 13 2016, estimating final liquidation value between $0.86 and $0.93. Shareholder vote will be held on Nov 10 2016 (record date Oct 4 2016). They will pay out $0.85 right away after the vote so the risk of capital being tied up is zero.

If you buy at $0.86, you are looking at around 0% to 8.14% return (excluding transaction costs and taxes). If you think you will receive around the midpoint of management's estimate, you are looking at around 3.49% return. (It's not easy to buy at $0.86 but it can be done; If you buy at $0.87, you will earn about 1% less with a potential for a loss of -1.15%.

Purchase Price: $0.86

Discounted Book Value (from Q3 2016, filed Aug 19 2016) [note: excl future Netherlands transaction])

(all in thousands)

Cash $87,164.00

Investments (@50%) $161.00
[listed Plateau Uranium, penny stock with low volume but likely can be sold over a period]

DEDUCT: Total Liabilities -$950.00

DEDUCT: cash from sale of Bermuda  -$2,361.44
[Aug 17 2016 Bermuda sale transaction sold for less than cash. Management acknowledges it. -- subsequent event after June period, Aug31: USD/CAD rate of 1.3050; was 1.2942 in last financial statements]

DEDUCT: Future corporate expenses until wind-down (estimate) -$1,500.00
[wild guess]

ADD: Inflow from employee options exercised $1,070.50
[refer to note 9 in Q3 financials for detailed option breakdown and average exercise price]

Net assets discounted $83,584.06

Shares Outstanding (Aug 24 2016 according to Khan website)
90,166,482 [fully diluted (incl assumption options exercised)]

Estimated liquidation value $0.93 [note: this was before company released its estimates; I expect final payment to be less than this]

Side note 1: Cancelling mining permits, often under dubious reasons of not meeting environmental or some related conditions, is one way foreign countries seize assets from investors (usually after a lot of hard discovery work has been done and a resource like gold or oil has been discovered and proven). Some may recall how the Russian government strong-armed BP, one of the largest oil & gas companies in the world, over environmental permit issues. Well, it's even worse for smaller companies. Mongolia basically took away the rights of Khan Resources and basically bankrupted the company (although there was a settlement in the end--too late for prior shareholders though). They also had a very serious dispute with Ivanhoe Mines (Turquoise Hill Resources) and Rio Tinto over the massive gold/copper deposit Oyu Tolgoi.

Side note 2: I never even knew there was a new exchange in Canada but KRI trades on the upstart Canadian Securities Exchange.

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Friday, September 23, 2016 0 comments

Purchase (Special Situation): Lexmark (LXK)

After a very long absence...

I decided to invest in the Lexmark (LXK) takeover by Chinese parties. The deal is expected to close this year and has an expected return (based on my assumptions) of around 8%. Although the company is somewhat different now, I did a lot of research about 5 years ago on Lexmark so I am somewhat familiar with it (it isn't a terrible business but it is definitely in a declining industry).

The main risk with this deal is the uncertainty over the CFIUS government agency approval.

Takeover price: $40.50
Deal closing: 2nd half 2016

Purchase price: $36.03

Prob (success) = 90%
Return  (success) = 12% (@ $36.03)
Prob (failure) = 10%
Return  (failure) = -31% <<< assume it drops to $25

Expected Return = 8%

Overall expected return isn't that high--I like to aim for at least 12% return--but given that the deal is likely to close within an year, the 8% return is good enough for me. The stock may decline 1-2% so if one can time it (and are lucky), they may hit 10%.

Risk arbitrage is uncorrelated with the market and that is one reason it interests me. Ideally, one should invest in numerous similar transactions for it to work well (but it's hard to find too many with 5%+ expected return without catastrophic deal failure scenarios).

Anyway, onto Buffett's classic questions on risk arbitrage...

Buffett's Four Key Questions

(1) How likely is it that the promised event will indeed occur?

I would say 90% chance of going through. The buyout consortium (Apex Technology and PAG Asia Capital) consists of a printer manufacturer whose business is in the same industry as Lexmark, and apparently one of the largest private equity firms in Asia. Closure is not contingent on obtaining financing and the private equity investor likely has capital lined up; funding appears secured. Risk lies with CFIUS, which is the American government agency that evaluates foreign takeover where national security is a concern. This entity is politically motivated and it is impossible to be certain of any outcome (their decisions are generally not consistent). However, most of Lexmark's business is straightforward business products and services with little national security issues. The only concerns are products sold to government agencies and I think Lexmark could structure the deal to avoid those issues if they arise.

(2) How long will your money be tied up?

Deal is expected to close by 2nd half of 2016. As soon as CFIUS ruling comes out, I expect the deal to close immediately. Based on a July 25 note to Chinese authorities by Apex, it appears that the CFIUS will respond 30 days after the initial submission (which seems to be July 15 (not sure?)) and complete a full investigation 45 days thereafter (source). A reasonable worst case might be 2Q 2017 (annualized returns will still be around 10%).

(3) What chance is there that something still better will transpire - a competing takeover bid, for example?

Zero chance of something better. Lexmark is struggling somewhat with downward revenue trajectory and not many parties interested in the printing business.

(4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?

Stock will likely drop to around $25 (about -31%), which is the low for the last few years. Given the somewhat low valuation--admittedly in a declining industry so it is to be expected--I will be content to hold it if the deal fails. According to Morningstar, LXK is trading around $2.3B market cap and a forward P/E of 10.2 (trailing P/E negative), P/B of 2.2 and P/S of 0.6. Long-time readers of the blog may recall that I closely evaluated Lexmark about 7 years ago and am familiar with it. It has changed somewhat in the last few years and wasted(?) billions of dollars on questionable software-oriented business documentation process acquisitions (including a little under $1B for Kofax and $0.25B for ReadSoft). Company still looks ok if it can manage its costs as revenues decline (and hopefully its software businesses increase their revenue).

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Monday, August 15, 2016 0 comments

Sold/Final Liquidation: Comdisco (CDCO and CDCOR)

I haven't done any investing in the last few years. In addition to being busy with some personal life stuff, I have felt the market is overvalued. In any case, one of my last special situations, a liquidation, I invested in 2009 finally made its final liquidation distribution.

Given the huge bull market over the last 6 years, this investment severely underperformed. However, I am ok with the outcome given how I was bearish and wanted something uncorrelated with the market.

One lesson to be learned from this investment is that liquidations can take much longer than one expects. I anticipated further delays when I made the investment but I never imagined it would last this long. It took approximately 7.5 years from when I invested (I was expecting it to close out within 3 to 4 years).

Comdisco (formerly CDCO -- security cancelled)
Purchase price (approx): US$ 7.00
Final distribution: US$ 4.564
Distributions: $3.1273, $2.3455
Total return (US$, worst case estimate*): 37.8% (4.37% annualized)

Comdisco Contingent Distribution Warrants (formerly CDCOR -- security cancelled)
Purchase price (approx): US$ 0.115
Final distribution: US$ 0.077
Distributions: $0.04985, $0.03739
Total return (US$, worst case estimate*): 51.7% (5.71% annualized)

(*worst case based on simple assumption that all distributions received at end. In practice, distributions were received in earlier years, 2011 and 2015, so the annualized return is actually a bit higher than what is shown.)

Another liquidation I have been recently looking at is Motors Liquidation Trust (OTC Pink: MTLQU). This is the former General Motors (GM) that went bankrupt (aka "bad GM" or "old GM"). It is a trust that is involved in litigation and makes distributions based on court case resolution. I haven't pulled the trigger yet and need to do more homework for a couple of reasons. I am not sure if there are adverse tax implications for Canadians who invest in this. The case is complicated and it's hard for me to tell if this is just a straight liquidation like others (such as Comdisco above). Furthermore, MTLQU has been selling off over the last few months and I can't figure out why. Not sure if it is because the market is hitting records and no one wants to be stuck owning this; or if it is due to recent negative developments with ignition key lawsuits GM is facing; or is it something else?

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Thursday, July 4, 2013 20 comments

How do App Developers Make Money? Seems Completely Unsustainable

Something that has always puzzled me is how software app developers on mobile platforms (phones, tablets) make money. Some mass market products, such as games, make money off large volume and/or advertising but how about all the others?

Writing for Stratechery, Ben Thompson illustrates the difficulty faced by app developers, particularly those developing productivity software (bolds by me):

Paper is a transformative, device-defining app, and has been awarded accordingly by both Apple and the design industry. According to App Annie, as of June 21, Paper ranked 7th in the Productivity category according to downloads (119th overall after a recent jump), and 4th in revenue (108th overall).

By every visible measure, FiftyThree, the makers of Paper, are the definition of an app store success story...
But underneath the surface, things aren't so rosy:
The problem for Paper is the same for all productivity apps in the App Store: there is no way to monetize your existing users...

My use of Paper is an essential part of stratechery, yet I needed to only pay $8.99 for two in-app purchases, for which I never need to pay again. That’s a hell of a bargain, but it’s ultimately unsustainable.
How can any developer survive on $8.99? Not only that, customers don't have to pay again for a long time (if ever).

Ben suggests (in other posts) several solutions, including the subscription model, but very few apps utilize that right now. The whole app industry seems ready to collapse in my opinion—unless their business model changes drastically.

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Wednesday, June 19, 2013 18 comments

The Power of Compounding; or How Good is Warren Buffett's Record Anyway?

Newbie investors often don't realize how much return an outperformance of 4% or 5% produces in the long run. Compounding is so powerful that, over a long period of time, the outperformance will be massive.

To illustrate, consider the returns of, arguably, the best investor of all time, Warren Buffett, versus the market (say, S&P 500). Warren Buffett has produced around 20% annual return whereas the market has returned around 10% per year (rough numbers, off the top-of-my-head). This is only a 10% outperformance but given how Buffett has outperformed for more than 40 years, the results are staggering.

Let me quote Jeff Matthews, from his well-written overview of the 2013 Berkshire Hathaway Shareholder Meeting. If you want a perceptive recap of the annual meeting, I recommend reading the entire blog post ("“We Want to Win”: The Berkshire Hathaway Annual Meeting, 2013 Edition").

...Berkshire’s stock is at a new all-time high—$162,904 per share for the A shares on the close Friday.

And considering that those same “A” shares were trading at $16 the day Buffett took control on May 10, 1965, well, it’s no surprise the crowd is feeling upbeat.

How Good Is Warren Buffett’s Track Record, Really?

But how good is Warren Buffett’s track record, really?

Well, Berkshire’s stock has appreciated—this is appreciation only, no dividends, mind you—981,150% since May 10, 1965.

And if you’d put $16 into the S&P 500 instead of into one share of Berkshire on that same day, your share of the S&P 500 wouldn’t be worth $162,905 today from appreciation (we’re leaving out the dividends for now.)

In fact, your S&P 500 share wouldn’t be worth $100,000 today.

It wouldn’t even be worth $10,000 today.

It would be worth about $600.

Throw in dividends and you’re north of $1,000 but south of $2,000 on your $16 investment. The Berkshire shareholder has $162,904.

That’s how good Warren Buffet’s track record really is.
Think about that! Just an outperformance of around 10% has resulted in approx. $160,000 vs $2000!

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Monday, March 4, 2013 5 comments

Sunday Spectacle CXCVI

Submarine Cable Map 2013
If you are interested in seeing how Internet traffic flows, check it out.

Click on image for larger picture; very high resolution of map available from source here. You can also purchase a map from the source.
(source: Submarine Cable Map 2013 by TeleGeography. Original mention by Fast Company FastCo Design)

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