Wednesday, May 28, 2008 7 comments ++[ CLICK TO COMMENT ]++

Sold/Tender Offer: Jaclyn... Plus BCE Thoughts

As I mentioned before, Jaclyn decided to go ahead with the forward-reverse split and the downgrade its stock listing to Pink Sheets OTC. I was slightly concerned a week ago about whether my purchase would run into problems because I'm in Canada (not clear whose account these shares are held) and I purchased two sets (249 each) under two different accounts I had. Well, it looks like it went through successfully and I received my payment. Good luck to Jaclyn in the future and all the best to its employees and shareholders. I will likely never hear about this company in the future given its tiny size and it being listed on the minor exchanges.

This risk arbitrage position has been successful in a short period of time. It's a small position due to the offer requirements but I'll take anything the way things are going : Average return of around 20% in C$ with currency losses shaving off about 2% (the unfashionable US$ still keeps declining ;) ). Big thanks goes out to Jeff, who runs the Circle of Competence blog, for bringing this to my attention. Often small investors feel like they are the underdogs--and we are--but situations like this allow us to capitalize on events that preclude the bigger players.

Sold: US$10.21

Total Return (1st account): 27.23% (approx. 29% in US$ terms)
Total Return (2nd account): 20.61% (approx. 22% in US$ terms)

Mixed Feelings on BCE Court Case

On another note, the bizarre situation surrounding the BCE deal seems to have entered unchartered territory with the Supreme Court of Canada willing to consider an expedited hearing. I'm not a "business guy" but there seems to be strong opinion in the business community here (as represented by newspaper, television, and magazine opinion) that the Quebec court decision was a mistake. We even have George Athanassakos, who teaches value investing at the Richard Ivey School of Business at University of Western Ontario, implying the BCE court decision was a mistake similar to the Bear Stearns bailout by the Federal Reserve. (I personally think the FedRes probably did the right thing with Bear Stearns but I think they made a huge mistake by not auctioning off Bear Stearns to the highest bidder (tramples shareholders) and shouldn't have guaranteed the Bear Stearns bonds (rewards creditors who finance highly leveraged institutions.)) There is still a high probability that the deal won't close successfully given that there are still big clouds over the bank financing.

Even though I would be financially hurt (in the short term; I think BCE will do fine overall), I don't think the court should hand down a rash decision. I think the Quebec court decision was a mistake but I do not think the Supreme Court of Canada should be rushing things since it has the last say on legal matters. I generally don't mind court cases dragging out at the highest level since the decision has an impact on many generations of future Canadians. To make matters worse, the Supreme Court can, in the future, refuse to hear a case without providing justification (the court does this all the time). So if they rule on something now, it can be very hard to overturn even if it's "wrong". Given that this is such an important matter where you are talking about the rights of bondholders versus shareholders, any decision can alter the face of Canadian business (although if the status quo is maintained then nothing is going to change).

It's a bizarre situation no doubt. Not only is this the biggest Canadian takeover in history, it is also very time-sensitive. I have no idea how the bondholders managed to delay the court case until the last minute but they somehow managed to do it. Interestingly, if we didn't have the credit crunch and the economic slowdown, the deal could be easily delayed. Unfortunately, as things stand now, the banks will do everything to avoid their financial commitment so delaying is equivalent to 'no deal'.

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7 Response to Sold/Tender Offer: Jaclyn... Plus BCE Thoughts

May 29, 2008 at 12:29 AM

Congrats on JLN

May 29, 2008 at 4:25 PM

Thanks... tiny position but good experience for me...

May 29, 2008 at 4:50 PM

Congratulations indeed on a succesfull arbitrage.

On a different note, I have just joined you on Ambac. Promises to be a wild ride back up with 10% swings on a single day. But after months of reading up on the company I'm finally confident the odds really favor a recovery. (I stumbled on this blog dredging the net for info on ABK and enjoyed reading your posts and links on it)

May 29, 2008 at 10:44 PM

ContrarianDutch, welcome to the world of Ambac. Hope you like the ride that you'll be taking ;)

Why did you pick Ambac instead of MBIA? What's your investing style and time frame (short-term, long-term, etc)?

Secondly, are you not concerned that the HELOCs and CESes may result in massive losses way beyond anything one expects?

May 30, 2008 at 3:35 PM

Thanks for the welcome!

This may try your patience a bit, long post...

I actually bought some MBIA as well, although it is a much smaller position. I emphasised Ambac because I think the stock is even more undervalued than MBIA. I bought some MBIA anyway as that company also looks like a good candidate for a major recovery. I intend to go for the long term, although given the extreme volatility I am toying with the idea of selling hard rallies and buying back after a temporary pullback one or more times as this could boost the return further (at the risk of missing the boat on a sudden jump)

As my name implies I prefer a contrarian/value aproach, buying things that have fallen out of favor et seem to have longer term prospects. Basically, if everybody really likes a company it's shareprice will reflect the high demand and high demand tends to push up the price. Even the best companies will be worthless investements if all their potential, and then some, is prices in.

I started investing late in 2004 and went for Dutch small caps which at the time were completely out of favor (and proved a fine investment, returning nearly 30% a year until last fall, many are still quit lowly valued especially after the recent correction)

Last fall I bought Dutch financials after their stock got slaughtered for no reason other then their status as banks/insurers and rumors of bad US mortgage debt on their books. Like you with Ambac I was too early in catching the falling knife and my first batch of purchases is still underwater. A second batch has done much better though and 6%/year or better dividends make waiting not so bad.

So getting back to Ambac.

If one assumes the marks to market, including the $250 million in April are indicative of the eventual losses to be suffered book value is still above $4/share
I bought at $3.01 so even if the marks to market turn into cash losses and the company goes into runoff the damage should be limited. This doesn't even account for the income that Ambac will have even in runoff over the next 5 years or so ($4 billion or so). Taking that into account $10-12/share seems reasonable. So I think potential downside is fairly limited. Only if the eventual losses are substantially larger then the marks to market taken will the company turn out worthless.

Now for the upside.

Ambac itself thinks it will take far fewer losses then the marks to market imply. Since they have a better view of their insured portfolio then anyone I'm inclined to think their estimate is likely to be more accurate then the bondmarket's blunderbuss approach, marking down everything US residential related. If the marks to market do reverse to a significant degree book value obviuously improves enormously as Ambac has about $7.5 billion of unrealizes losses on it's books.

Tom Brown of wrote some articles that have helped convince me that the market has priced in absolutely insane levels of default on US mortgages, so I think is likely the marks to market will partly reverse.

last but not least, the real damage (in actual defaults) is being done disproportionately by a small numer of issues that have proven to be total crap (mostly the CES/HELOC stuff that you mention). Ambac says it will try to shove this back to the banks that packaged these securities and it might just prove succesfull at this as these issues probably contain lots of " liar loans" and the banks may well be in violation of representations and warranties on their part about the quality of te collateral. Also, the banks will not want a very public defeat in court, so if Ambac has a fair shot at winning a case a settlement is likely especially as $1-2 billion is a lot for Ambac but almost small change for the banks who have already eaten a big multiple of that in losses of their own.

The CES/HELOC losses could get out of control but Ambac has a very helpfull presentation on it's website breaking the exposure down in a number of different categories. The real problems are concentrated in a fairly small segment (non-bank originated 2006/2007 CES/HELOC). Ambac will take losses on CES/HELOC but very severe losses are already priced in so it will be difficilt to outdo the market expectation. Eeven if 50% of the entire pile of real nasty stuff (non-bank originated 2006/2007 CES/HELOC)turns out worhtless, that is still survivable ($2,25 billion loss approx.).

Last but not least, while there is a possibility that the bears are right and Amac turns out to be insolvent the stock is now essentially priced as an option of indefinite duration. I think the chance of insolvency remote and if the marks to market reverse and Ambac manages to recapture market share the upside is huge. Potentially 10x the initial investment or better if everything goes right.

Okay, there you have the outline of my thinking on Ambac in one wohpper of a post.

June 1, 2008 at 12:34 AM

Thanks for the post ContrarianDutch. I appreciate you taking the time to write up that long post.

Your thinking is also what led me to Ambac initially. Unfortunately, management messed up and ended up diluting shareholders (basically gave away 60% of the company) so the initial book value got killed and it's hard to make money off the initial investment (although if most of the mark-to-market losses reverse the book value will be in the $20 to $25 range, with adjusted book value probably in the $30-$40 range).

I've been thinking of averaging down due to reasons similar to what you are saying. The book value (or adjusted book value--this is the true value of the firm if it is in busines for the long run) is higher than the current price. This is just speculation on my part but I think a lot of the mark-to-market losses on many CDOs and direct RMBS will reverse in the future (I have also read Tom Brown's articles and he thinks it may happen very soon). BUT the big worry are those HELOCs and CESes whose marks, even though only a small number are showing problems, may be real nad end up with 100% loss. I personally don't put much weight into legal recourse with these deals. Even though management seems optimistic, it is totally unpredictable and Ambac/MBIA/others have to pay first anyway.

I'm waiting anxiously to see if Martin Whitman comments about the bond insurers in his second quarter update. Now that Ambac is publishing the monthly credit status, it should allow us to observe what happens. Until the marks stabilize I think the stock price will be under pressure.

June 1, 2008 at 9:47 AM

Very severe losses are priced in, includingon CES/HELOC. Only if things turn out much worse then the marks to market imply will Ambac suffer more. This seems unlikely.

Any recovery from legal action is potential additional upside. Full losses are priced in.

Actually, my main worry is that muni debt could blow up. the problem with structured credit in it's various forms is known and reasonable loss estimates can be made. Still, everybody assumes that the muni debt will be loss-free even though local governments will see big revenue declines as real estate prices tank. Moreover, how many US municipalities have signed up for financial engineering of the kind that exploded in the face of Jackson County?

I do think that on balance the risks are acceptable while the potential upside is huge (if ABK does go back above $30/share I can look forward to millionaire status, at least in dollar terms).

Last but not least, if we do get the " 10 year depression and a world war" that the superbears are predicting the value of my investments will be among the least of my worries.

(if I seem to be commenting here quit a bit suddenly, you are right. I enjoy being able to "talk" about this and usually draw blank stares if I mention stocks, let alone ABK)

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