Wednesday, November 30, 2016 0 comments ++[ CLICK TO COMMENT ]++

Opinion: Potential Consequences of Trump Presidency

Given the unpredictable nature of Donald Trump and the lack of a well-articulated platform and ideology that he adheres to, it has become a cottage industry to predict how the US government over the next several years--at least until mid-term elections in 2 years--will behave. I don't like Donald Trump, his policies or the people he surrounds himself with--Steve Bannon, the ex-Goldman Sachs banker/ex-film producer and almost-far-right proponent, and Bill Walton, the former Allied Capital CEO who some of you may recall being profiled by David Einhorn over a decade ago with some employees eventually being convicted of fraud come to mind (it's almost farcical that Trump would put Walton in a role to influence the policies of the SEC and SBA when those two agencies contributed to the conviction of wrongdoing by Walton's firms)--but as I have mentioned in the past, unlike most other countries, the US President has far less power than many imagine. Having said that, since  the Republican Party controls the House and the Senate, and will likely pick key justices for the Supreme Court, Trump will likely get through quite a number of his policies (unlike the Obama presidency where he couldn't get the Republican House to agree to anything substantive (except foreign wars)).

If you are a pure value investor then you should just ignore what is happening in econopolitics and focus on companies. Otherwise, if you are more macro-oriented like I am, it's worth contemplating some scenarios.

The market has rallied strongly over the last couple of weeks but I see all sorts of conflicting behaviour. For instance, I think the movement in the US$, equity prices and inflation expectations are contradictory with each other to a large degree. I think one of these elements will overpower the others.

Some have suggested the market is starting to price in high inflation. It's not clear to me that this is the case. There is definitely more inflation being priced in but not "high" inflation. If you look at the TIPS breakevens (10yr here; 30yr here), it doesn't look like a drastic change. The chart below of the 10yr breakeven:

(source: St Louis Fed Res FRED, downloaded Nov 29 2016)

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Sunday, November 27, 2016 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle CCII

Interesting Facts about the US Currency


I ran across a good Dallas Federal Reserve publication ("Money" from 2013) that explained the basics of money. It is one of those government propaganda-type publications aimed at the general population but, surprisingly, it does a good job of going over almost all the major concepts related to money including inflation, expansion of the money supply due to multiplier effect of reserve banking, and even highlights the major events (such as Bretton Woods, FDR banning ownership of gold, etc).

Anyway, it had some interesting historical facts that very few, including Americans, know about the US currency and I thought I would post it here. I certainly didn't know about them. For instance, I knew about the era when banks issued their currencies but didn't know there were 30,000(!) distinct currencies in USA at one point. This implies that there were maybe 20,000 banks (another 10k could be other entities) and that surprises me given how America wasn't that big in the 1800's. Also didn't know that a $10,000 bill existed.

Finally, the most interesting fact I learned--I doubt even 1% of anyone who visited this blog since inception know this--had to do with overprinted US currency issued in some areas in case those areas fell under foreign ownership during WWII. Seems like a draconian move to punish citizens in those regions if they went over to the foreign side (imagine if most of your net worth, at least whatever is in currency form and in banking accounts*, became worthless if your region was taken over by a foreign country during war.)

(* This is another reason why it is preferable to hold your wealth in physical assets or even securities like company shares. Governments could easily alter currencies. Incidentally, in India, within the last month, the government has undertaken some draconian measures by banning two of the most popular bills, which apparently represent 86% of currency in circulation. Apparently it was to combat corruption but the most impacted are the poor who don't even have bank accounts--some stats indicate that 50% of Indians don't have bank accounts--and it will only weaken the confidence in the country's currency--what's to stop the government from doing something similar again in a few years?)


I can't upload it properly as one large image so I have broken it up into 3 pieces. Click on each one for larger image.





(source: "Money" by Federal Reserve Bank of Dallas, 2013. Only portions of the document are extracted above and graphic layout altered from original document.)

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Saturday, November 26, 2016 0 comments ++[ CLICK TO COMMENT ]++

Articles of Interest for the week ending Nov 26 2016

Here are some articles I read recently that you may find interesting. This time around, very few are investing-related...

  • "Google, Facebook, and Microsoft Are Remaking Themselves Around AI" (Cade Metz for Wired): Overview of how these tech companies are leading the research into AI.
  • "Inside Fitbit’s Quest to Make Fitness Trackers Invisible" (David Pierce for Wired): I was thinking about wearables as a potential investment. In particular, Fitbit (FIT) has sold off since the IPO--it's kind of confusing since it seems like there was a big share dilution along the way--but is this a fad or is it the future? Fitbit certainly has the leadership position and strong brand (so far) and its balance sheet and income statement looks ok too. I probably won't invest since history is too short and it's hard to predict the future but I'm studying it a bit.
  • "Can America’s Companies Survive America’s Most Aggressive Investors?" (Alana Semuels for The Atlantic): Debatable argument on whether activist investors are too short-term-oriented and hurting the long-term success of corporations and the country. One can never be sure with these things. Companies are cutting back R&D and not investing in workers or plant & equipment, but is that because of excessive short-term pressure or is it because opportunities aren't available or they are unable to compete against other companies (possibly from other parts of the world)?
  • "Mapping the End of Malaria" (Bill Gates): Gates Foundation has played a major role in combatting malaria--did you know that mosquitoes are the #1 killer of humans?--and Gates suggests that Malaria may be eradicated by 2040. If so, it will definitely be the #1 accomplishment in human health for the 1st half of this century.
  • "Our Driverless Future" (Sue Halpern, New York Review of Books; review of 'Driverless: Intelligent Cars and the Road Ahead' by Hod Lipson and Melba Kurman): Author goes over the developments in driverless car technology and its potential societal impact. I think it is going to take much longer than many believe but when it does happen, it will be revolutionary.
  • Bill Gates on Warren Buffett (article here and slideshow here; July 5, 2016): Gates briefly recounts the first time he met Buffett and has some photos of their private lives.

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Tuesday, November 22, 2016 0 comments ++[ CLICK TO COMMENT ]++

Newbie Thought: What Type of Investment Edge Do You Have?

I was listening to this Manual of Ideas podcast with James Roumell and he briefly mentioned the three  types of edge investors could have and I thought it was worth thinking about. The three of them are:

  1. Information edge
  2. Analytical edge
  3. Behavioural edge
There are many different ways of slicing and dicing the idea of investment advantages that are required but these three do a good job IMO.

This is a very simple thing but it is always worth thinking and periodically reminding oneself about basic concepts in investing.

Information Edge

Information edge is when you have knowledge that most others--say the market as a whole--doesn't possess. Some people do it through illegal means but we are talking about fully legal activities here. It sounds like James Roumell believes this may his edge. Those with large budgets may get an edge by sourcing information that is not easily accessible to others, either due to cost or exclusivity (for example, getting very detailed market research data, or foreign country data). In most cases, it involves acquiring information that the market doesn't know about by talking to customers, competitors, management, and so forth. It might involve going to industry conferences, physically visiting the company, checking out the goods/services being sold, etc.

Essentially, scuttlebutt and hitting the road.

Warren Buffett used to do a lot of this in his early days of investing. For instance, he used to count railroad cars, or go to government agencies/libraries to search for public records no one else bothered looking at. I'm not sure how much this helped Buffett but he did suggest several times that he gained a lot of knowledge from his early scuttlebutt-type work and because of that, he didn't do it later on.

I think if I was a professional investor, I would do more of this. If you are a professional investor, you should seriously think about seeing if you can develop an information edge somehow (Roumell suggests others do more of this as well). Not everyone is suited for this but you never know until you try.

Having said that, it is usually hard for amateur investors to develop an edge this way. There are two difficulties with trying to get an edge this way. Firstly, it is costly, hence not worth it if you have a small portfolio. You have to pay quite a bit to acquire information (such as market research data or highly specialized industry reports). It can cost thousands to attend industry conferences or subscribe to industry trade journals.

Secondly, amateur investors just don't have time. Even if you are dedicated to investing and it is your primary hobby, you only have a few hours per day. It's kind of hard to go to conferences or visit numerous locations and so on. Maybe you can get away with it if you are only looking at local companies where you live but otherwise it's tough. I find that even listening to the quarterly conference calls, which don't really give you much edge since everyone listens to them (it's more to just "keep up" and understand basic things), is already time-constraint.

Analytical Edge

Developing an analytical edge probably looks the easiest, but is likely the hardest. You have to be naturally talented or develop above-average investing skill through experience and knowledge.

This is the one that most amateur value investors gravitate towards, at least from what I see on the Internet. Certainly this is the one that you can do sitting at home.

I don't have much to say on this because it isn't easily explainable--investing has elements of art and science--and only a few will outperform, although there are multiple paths. There isn't one way to analyze an investment.

This is probably Warren Buffett's greatest strength. The way he analyzes companies is truly remarkable and unmatched by anyone. He is a superstar for sure. It's amazing how he can look at financials that are available to everyone else and make a decision within a few hours. In fact, he does that even when there is very limited information, as with most private companies he buys. It's just amazing. I am also impressed whenever I look at some investments that look "dumb" whenever everyone else, including me, look at them but turn out to be very good. His purchase of high P/E companies in low growth, mature, industries involve superior analysis and I'm always impressed by them.

Small investors are probably on an even level with professionals when it comes to analytical edge. Professionals do have teams of analysts that help them out but one person's superior analysis is better than a whole committee of decision-makers.

Behavioural Edge

People may have differing views of what a behavioural edge is, but I take it to mean that you don't succumb to "bad behaviour." Namely, you shouldn't blindly follow the crowd; you need to do something a little bit different from others; and so on.

Amateur investors probably have an automatic edge in this but it is hard to master. It's probably something you are born with. Professional investors will have a difficulty with this because fund management is very pro-cyclical and correlated with bull markets. Fund manager's behaviour matters less than what the fund investors do: when fund investors start pulling money out during corrections, it's hard for fund managers to act independently.


To sum up, in a simple sense, there are three ways to have an edge on the market and the rest of the competition. So, which of these are you good at? Which one can you beat most others with? Something to think about.


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Monday, November 21, 2016 0 comments ++[ CLICK TO COMMENT ]++

Bloomberg Markets on Renaissance Technologies

Arguably the most successful hedge fund of all time is Renaissance Technologies' Medallion fund. I don't know much about hedge funds and don't have visibility into any of them, and furthermore, Renaissance is very secretive, so I'm just going by what others say. Since many people keep saying the same thing, I suspect Renaissance is indeed as good as it is.

Bloomberg Markets has a very good article on Renaissance Technologies, "Inside a Moneymaking Machine Like No Other." Given how the fund is secretive, there isn't much that is known but Katherine Burton, the primary author, does a good job with whatever is available. Even if you are not a quantitative investor, well worth a read for a markets history perspective.

Medallion is a quant fund and Renaissance employs numerous, highly educated and highly skilled, mathematicians and scientists. The founder of Medallion, Jim Simons, is a former mathematics professor.

Medallion's record is truly remarkable. It posts something like 50% per year on a $10 billion fund, including through bear markets.

(source: "Inside a Moneymaking Machine Like No Other," Bloomberg Markets. Nov 21 2016)


Extremely skilled small investors may be able to generate 50% per year on a small portion of a few million but it is almost impossible for a $10 billion fund. Having said that, Renaissance doesn't retain its earnings so it prevents itself from getting bigger.

Of course, when you post very high returns, it can be fake/fraud/misleading-numbers or it can involve a lot of skill. Some will always argue it is fake or a fraud--just like how numerous people claim Warren Buffett is a fake and Berkshire Hathaway will go bankrupt when he isn't around--but I don't believe it is. I do think Renaissance is for real.
For outsiders, the mystery of mysteries is how Medallion has managed to pump out annualized returns of almost 80 percent a year, before fees. “Even after all these years they’ve managed to fend off copycats,” says Philippe Bonnefoy, a former Medallion investor who later co-founded Eleuthera Capital, a Switzerland-based quantitative macro firm. Competitors have identified some likely reasons for the fund’s success, though. Renaissance’s computers are some of the world’s most powerful, for one. Its employees have more—and better—data. They’ve found more signals on which to base their predictions and have better models for allocating capital. They also pay close attention to the cost of trades and to how their own trading moves the markets."
...
At their core, such models usually fall into one of two camps, trend-following or mean-reversion. Renaissance’s system had a foot in both.
...
How much money an employee has in Medallion depends on his overall contribution to the firm—and collaboration is key to getting a bigger piece of the pie. Employees are awarded an allocation of shares they can buy. In addition, a quarter of one’s pay is deferred and invested in Medallion, where it stays for four years. Employees must also pay fees of as much as “5 and 44.”

Simons determined, almost from the beginning, that the fund’s overall size can affect performance: Too much money destroys returns. Renaissance currently caps Medallion’s assets between $9 billion and $10 billion, about twice what it was a decade ago. Profits get distributed every six months.

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Sunday, November 20, 2016 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle CCI

Global Agriculture

Some important agricultural graphics I extracted from Syngenta's "Our Industry 2016" report (PDF direct link)...

(As with most graphics posted on this blog, you can click on the image for a larger one)





(Image source: Syngenta, "Our Industry 2016"; PDF direct link)




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Saturday, November 19, 2016 0 comments ++[ CLICK TO COMMENT ]++

Articles of Interest for the week ending November 19, 2016

Since getting back into investing, here are some articles I found interesting/worthwhile. Since I'm catching up, some are really old so you may have seen them already (if it is stock ideas or macro themes, pay attention to date it was written). Hope you find them useful.

I'm also trying to rebuild my blog and website list. Quite a number of blogs I used to read are gone or don't really cover what I find useful. If anyone has blogs that are worth following (especially anything new started in the last 3 or 4 years), let me know (email me or leave a comment at the bottom).

  • (Recommended) "Should You Buy Net-Nets or 'Desert Island' Stocks?" (Geoff Gannon for GuruFocus): Good to see Geoff Gannon writing articles again. I probably learn more from Gannon than anyone else on the Internet. Lately, I have been reading through his past articles at GuruFocus and there is always a nugget I pick up from each one. The linked article is one that touches on the investing approaches small investors can pursue. Gannon basically touches on what I call classic value investing (net-nets, companies trading below liquidation value, focus on assets, etc) vs event-driven (risk arbitrage, liquidations, spinoffs, etc) vs Buffet Prime (buy & hold forever, great businesses, strong moat, high ROE, etc). I share Gannon's views that event-driven type investing and Buffett Prime type are probably the best ones to pursue in USA (and Canada). In other countries, the situation may be a bit different (in developing countries, maybe you'll find higher quality net-nets but no special situations since corporate restructuring is limited). My personal opinion is that, just like anything else in life, there isn't one path to take. Many roads lead to success and you need to find the one that works for you. Too many people attempt to clone Warren Buffett without realizing the amount of skill or effort required. That's like people trying to be Michael Jordan or Wayne Gretzky without having the talent; better to figure out and focus on your strengths instead (more in the next bullet, article from Howard Marks). Also, the vast majority of investors will fail and won't beat the market--maybe even me. If you don't have an interest in investing, and aren't performing well (in the medium to long-term), you may want to focus on other things in life. If you like doing it, that's fine but otherwise, one needs to realize their limitations.

  • (Highly Recommended) "It's not Easy" (Howard Marks, Oaktree Capital, Sept 9 2015): I might write a standalone post on this in the future but in any case, this is a great piece from Howard Marks on how investing actually requires a lot of work and thinking. He quotes Charlie Munger as saying "It's not supposed to be easy. Anyone who finds it easy is stupid." Newbies who haven't read this should definitely read it.

  • (Recommended) "You can't Eat IRR" (Howard Marks, Oaktree Capital, July 12 2006): I used to use personal finance software (MS Money and Quicken) to track my portfolio but am down to computing everything by hand in a spreadsheet. So, I was revisiting this classic piece on how to measure returns properly. Some of it is not applicable to small investors but it is good to set up a system so that you understand how annualized returns can differ from IRR and how opportunity cost of not deploying capital (holding cash) should be factored in.

  • "Measuring the Moat - Credit Suisse" (Credit Suisse, h/t Hurricane Capital): Ran across this new blog, Hurricane Capital, that is quite good (the author transcribes some key points from videos he links to so his blog so that's something different and takes effort). The author cited the updated Credit Suisse report on moats. I read the old one (some of it at least) from years ago and it is quite good. If you want to read about moats that is not a book, it worth spending your time on this. The thing about moats, though, is that it is easy to identify in hindsight but hard when the business is building it. Also, even if you identify one, you might be looking at its peak and it can disintegrate; many value investors don't seem to pay attention to that.

  • Ritholtz Bill Miller interview (Bloomberg audio podcast): I am probably one of the few who still believes in Bill Miller. Many wrote him off him off after the financial crisis as someone lucky and unskilled, but I still think he is one of the best investors in the last few decades (especially for the size of the fund he was running). I haven't capitalized on anything yet but he definitely changed the way I think about growth stocks. I think he is prone to blow-ups given the type of investor he is (a bit speculative, kind of like Mohnish Pabri) and don't necessarily agree with Miller on everything, but you can't deny that he brings a different perspective on many issues. For instance, I don't share his view in the interview that stocks are cheap--he, like most institutional investors, are comparing it to bonds--but he is probably right that bond yields may have peaked (apparently global bonds hit a 5000 year peak in the summer). His bullish view of Amazon is also hard to accept--he seems to rely more on the Silicon Valley approach of looking at addressable market, which is extremely large for Amazon (relatively speaking, Amazon is barely where Walmart was in the early 90's), rather than on current and future "probable" earnings. He does make a strong point that Amazon is one of the few companies with $100 billion in revenue that is able to grow it 20%+, a truly remarkable feat for sure.
  • "Bob Diamond's Misadventures in Africa" (Bloomberg, Oct 11 2016): Profile of former Barclays CEO (who stepped down after LIBOR interest-rate manipulation scandal--not clear but I don't think he is ethically challenged) who is running a new fund/holding company, Atlas Mara (trades in London, LSE: ATMA). I find his company interesting because it gives investors an opportunity to invest in Africa. Not only that, his fund is exposed to frontier African markets rather than the popular, more developed, South Africa or Kenya. Africa is the least developed region, which consequently means it has the highest growth potential. It is also one of the most corrupt--only parts of South Asia and Central Asia are more corrupt in my opinion--and filled with quasi-dictatorships (many are run by democratically-elected-dictators). So if someone is interested in frontier markets and wants super-high-risk/very-high-return potential, this is the place to look. When an economic growth is good, one of the absolute-best sectors to invest is financial services (especially banks and stock exchanges in undeveloped/developing markets). Atlas Mara is a holding company with stakes in several banks and is trying to consolidate them into larger, more efficient, operations. The stock is down something like 80% since IPO because their banks are doing terribly. The commodity bust has negatively impacted many of those countries and loan losses are high. Some of their investments were likely duds and they might have spent millions on worthless banks. Assets are likely overstated and probably worth less than what's on the books. Management skill is also unclear, although Bob Diamond built up Barclay's Africa operations over the decades so he knows the region (he is also apparently good with forex which is where Atlas Mara is making money right now). What makes this worth looking at is the fact that Price to Book is something like 0.4 (I haven't looked deeply and confirmed it). Assets are likely overstated and asset quality is likely poor but even then, after adjustments, if P/B is less than 0.6, it is worth investigating given the long-term secular banking growth (if you are ok with high-risk investments). There is a risk that management may destroy shareholder wealth by raising funds by issuing shares way below book value but hopefully they don't. Unfortunately, I don't really understand financials--outside my circle of competence--so any investment will be more speculative than anything.

  • Syngenta 2016 Industry Report (PDF; alt website link): Was studying the agricultural industry and found this industry report useful (it's similar to the ExxonMobil oil & gas industry report, which is one of my favourites in the energy sector). Things have changed so much in agrichemicals/agribiotech industry in just 5 years. I invested in Syngenta (SYT) as a risk arbitrage position and it has sold off significantly recently (possibly due to increased deal failure risk from the election of Trump and his impact on European regulatory agencies; if Trump blocks the Monsanto merger or severely penalizes Chinese companies, then maybe the EU will block the Syngenta buyout). Anyway, I was wondering if I should raise the stake (you are looking at something like upside of 20% and downside of 30%, depending on stock price). Deal might fail so not sure if it's worth it. I always liked the company and was looking at it more deeply as a potential long-term investment (I would have no problem holding this company long-term). The problem I see is that the industry did really well in the 2000's but has gone nowhere in the last 5 years.

  • "Can Monsanto Save the Planet?" (Fortune): I also was researching Monsanto (MON), which is a competitor to Syngenta (although Monsanto deals more with seeds and Syngenta with crop protection chemicals). I'm thinking the stock may be worth investing if the merger fails and stock falls 25%+ from here. Monsanto has been one of the most hated companies in America in the last 50 years. Some of it for very valid reasons: Monsanto has been in some of the most serious health controversies in American history. It was a major producer of harmful chemicals such as DDT, PCB, and Agent Orange. That was the past. Recently, over the last two decades, it has been controversial due to its main business, genetically-modified-organism (GMO) products. Namely, Monsanto invented and pioneered genetically-modified seeds. It is also controversial for enforcing patents and going after farmers that violate its GMO seed policies. Presently many countries, particularly in Europe, are very concerned and resistant to GMO food. The impact of GMO foods will not be known until decades afterwards but GMO foods are one of the most regulated and scrutinized products so I am somewhat less concerned than others. Everyone has a moral compass and you need to decide if you want to invest in such a company. For instance, I don't invest in weapons manufacturers (so-called Aerospace and Defense industry) or tobacco. But I have no problem with Monsanto. The industry has not done so well over the last 5 years and because this is a high P/E (high ROE) stock, one needs to be clear on the future prospects. Hard to tell but the stock probably trades at a discount due to its controversial nature.
  • "Salt at the source: A day in a Lake Huron mine" (TheStar.com, date unknown): I am researching Compass Minerals (CMP) as a potential investment and ran across this video/photo overview of their main salt mine. Compass' valuation appears high and not sure what its long-term stable earnings are. I will do a detailed write-up if I research more.

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Thursday, November 17, 2016 0 comments ++[ CLICK TO COMMENT ]++

Jeremy Grantham 3Q 2016 Letter: Not a Classic Bubble

I'm getting back into investing and one of my favourite big-picture thinkers is Jeremy Grantham of GMO. One of the things that makes this blog not much of a value investing blog--I don't necessarily consider myself a true value investor--is my incorporation of macro thinking. Grantham's latest 3Q 2016 letter is out and he devotes it to the high market valuation, which in my opinion is a bubble. He essentially suggests that valuations are high and will mean-revert, but doesn't think it will happen quickly as in most large bubbles. He thinks the most probable outcome is a drawn-out mean reversion.

I don't necessarily agree with Grantham on everything--for instance, I'm still not sold on his recent bullish call on (some) commodities and his thought that oil will hit $100 again (within a reasonable time period)--but he is an expert on bubbles and is one of the few that was bearish on the 2000 and 2008 bubbles (apparently also the 1989 Japanese bubble too but I wasn't investing back then ;) ). Although Grantham and his firm GMO isn't 100% perfect with their asset forecasts, they are mostly right than wrong. He is one of the few that I am aware of who treated timber as a major distinct asset class and was bullish long before anyone else (this wasn't an investable asset for small investors but it was valuable to pension funds and other large funds).

For macro-oriented investors, I highly recommend reading his 3Q 2016 piece, "Not with a Bang but a Whimper (and Other Stuff)," which is the 2nd letter in the document at GMO (main site here).

Click through for my full thoughts. Underlines are by the author but as is usually the case, bolds and square brackets are by me. I don't like quoting so much but I'm going to do it here since Grantham writes so well and his thoughts are very valuable for future reference.

Well, the US market today is not a classic bubble, not even close. The market is unlikely to go “bang” in the way those bubbles did. It is far more likely that the mean reversion will be slow and incomplete. The consequences are dismal for investors: we are likely to limp into the setting sun with very low returns. For bubble historians, though, it is heartbreaking for there will be no histrionics, no chance of being a real hero. Not this time.

...

Hidden by the great bubbles of 2000 and 2007, another, much slower-burning but perhaps even more powerful force, has been exerting itself: a 35-year downward move in rates (see Exhibit 1), which, with persistent help from the Fed over the last 20 years and a shift in the global economy, has led to a general drop in the discount rate applied to almost all assets. They now all return 2-2.5% less than they did in the 1955 to 1995 era (or, as far as we can tell from incomplete data, from 1900 to 1995).

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Wednesday, November 16, 2016 0 comments ++[ CLICK TO COMMENT ]++

Talk about Short-covering Rally -- Shippers Rise 500%+

Some shipping companies had one of the biggest short-covering rallies in recent memory when they rose 500% or more within a few days.

(source: Yahoo! Finance, downloaded November 16 2016)

I came across this unusual outcome after reading the story at Marketwatch. There are always some crazy short-covering rallies but I haven't seen, nor heard of, such huge moves across multiple stocks. DryShips had a recent reverse stock split and not sure if that threw off some quantitative fund or something.

The stocks above are for DryShips (DRYS) and Globus Maritime (GLBS). These are shipping companies and long-time readers may recall how I have touched at the extreme volatility of DryShips and dry bulk index, and even wondered several years ago if DRYS was an investment opportunity. The whole industry is distressed and facing some catastrophic problems. I have been looking lately at Navigator Gas (NVGS) and Seacor (CKH) but the issue is the massive overcapacity. For instance, Navigator Gas is seeing declining prices and shipping volumes yet it is contractually committed to pay and take delivery of even more ships over the next few years--so are some of its competitors! So the situation is not pretty at all.

Companies like DryShips are on the verge of bankruptcy and the shares are essentially extremely-low-probability-potentially-high-return "options." As the chart below shows, the company had a similar huge rise near the Financial Crisis in 2008 and collapsed. This time around, it may be the final nail in the coffin...

(source: Yahoo! Finance, downloaded November 16 2016)

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Monday, November 14, 2016 2 comments ++[ CLICK TO COMMENT ]++

Berkshire Hathaway Bets on US Airlines

Berkshire Hathaway just disclosed that it took stakes in major US airlines. Pretty sure it is not Warren Buffett, rather his co-CIOs, making these investments. Buffett joked that he wouldn't invest in airlines after his disastrous--disaster for him is exiting with a small gain ;)--bet on US Airways in the 90's and, although he can always change his mind, I doubt he did. Also, Buffett usually makes concentrated bets and this isn't one. What is interesting to me is that they seem to be making a sector or macro bet since they took stakes in multiple airlines--either that, or they are trying to obscure their true intention (the stock they want to own) but buying multiple ones.

It was only yesterday when I was commenting on Mohnish Pabri and his investment in Southwest Airlines (LUV). I wondered if the airline industry has changed from its money-losing ways. I wonder if the Berkshire investment managers are thinking the same thing. In an interview with CNBC Buffett confirmed that Berkshire also took a stake in Southwest Airlines (this happened after the end of the quarter which the 13F filing reflects). Really interesting to see Pabri take the same position.

One possibility is that the Berkshire CIOs are betting on airlines due to the decline in oil prices, which are a major cost for airlines. Although they may factor this in somewhat, I doubt this is the case since pure value investors don't generally speculate on future commodity prices.

In the Alaska Airlines-Virgin America merger presentation, the following slides were presented to illustrate how the American airline industry is supposed more profitable now. This document is likely biased (since it is there to sell the merger) but it is something to think about. Has the airline industry really changed?

(source: "The Premier Airline for People on the West Coast," Alaska Airline and Virgin America. Flyingbettertogther.com)

The bottom slide clearly illustrates that the top 4 carriers have 84% of the market share, whereas as recently as 5 years ago, it was only 65%. Either economies of scale or pricing power could have led to improved operations for those top 4 carriers.

One thing going against an investment right now is that P/E ratios are very low right now. According to this Bloomberg article, TTM P/Es for the 4 largest US airlines are around 8, with American Airlines actually trading around 5. Cyclicals should generally be bought when P/Es are high (or infinite i.e. loss). I haven't done any research but one should be careful that they are not buying these companies near peak earnings, with high risk of markdowns during economic recessions--a recession and a stock market correction is way overdue and I think we will have one very soon.

Maybe it is worth investigating airlines as potential investments. This is certainly an industry that has historically been ignored by many amateur investors, for very good reasons.

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Mohnish Pabri Peking University Speech (Oct 2016)

I ran across this after someone on Twitter mentioned that Mohnish Pabri, a successful value investor, started a blog and has posted a few videos of his speeches. I'm not huge fan of Pabri--his style is a bit different from what I want to be and his holdings always seem very risky if you don't know what his reasons are (which is never clear to most amateur investors)--yet it is worth listening what he has to say. Pabri often raises some items often ignored by many and he is very open and speaks his mind.

Mohnish Pabri, in my opinion, is a deep-value investor who focuses on cyclicals. Not everything he does fits that description but I do notice the unique thing about him is his tendency to invest in cyclical companies. As experienced investors, or at least those that have studied history, know, sometimes it is very hard to tell if some company is facing structural decline or a cyclical decline. This strategy has the potential for huge losses if you end up stuck in a structural decline when you thought it was a cyclical trough.

His new blog is The Compounders, although the URL is know72.com, and it seems like he has included a lot of his past material. I'm not sure why he started a blog right now--doesn't seem like it is related to his business or will help his investments in any way--but it's a benefit to amateur investors. Interesting to me are his old articles, including a few which detail his analysis. In particular, I'm working my way through this one, "The Intrinsic Value of Microsoft, Intel, and Cisco" which details his analysis in 2000. You might want to read some of his other articles there as well, although I didn't find enough depth in many of them.

What does have depth--it certainly is very long and I haven't listened to all of it yet--is Mohnish Pabri's latest online lecture/speech at Peking University (apparently held on October 14, 2016). I don't follow Pabri closely like some others do, so I learned quite a bit about him. I don't agree with everything he says/implies but there are some thoughts that investors might find beneficial. For instance, he cites Guy Spier's, a value investor from Europe, strategy of identifying very-good businesses with superior industry characteristics and then looking for something similar elsewhere in the world. The one he cites is the credit rating agency Moody's, which has a very good business (basically an oligopoly), and then trying to identify other businesses like it elsewhere in the world (the one Guy Spier found was apparently a rating agency in India in early 2000's that was undervalued). This is a good strategy to add for global investors: find a great business (possibly in a developed country) and then find a similar one in another country (possibly in an undeveloped or developing country where the industry is in its early stages).

One thing about Pabri that one has to be careful with, if you are blindly investing in his stock picks, is that he invests in cyclicals and such investing approaches are very risky if you get the macro case or some industry change wrong. For instance, early in the video he talks about his investment in a Canadian steel company in the mid-2000s(?) (I forget the name) and it sounds easy in hindsight but it would have been a difficult and possibly risky decision at that time (if you didn't know why the market was pricing it so low). Right now, Pabri is long Fiat Chrysler (FCAU) and Ferrari (spin-off from Fiat Chrysler) precisely when the auto market appears to be near a cycle peak. It seems he recently took a stake in Southwest Airlines (LUV), which seems like an interesting pick. Airlines have been one of the worst industries in a century; but if the Alaska Airlines reference I alluded to (in my Virgin America risk arbitrage post) is correct (namely, airline industry dynamics changed in mid-2000s and industry is actually structurally profitable now), airlines are not as bad as they historically have been. Haven't done much research but apparently Southwest is examining international flights, and if it could do what it did to domestic American flights, it could be revolutionary for low-cost flyers.



If I get some time and feel like there is enough to write, I might touch on some of the ideas he expounds in a future blog post.

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Sunday, November 13, 2016 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle CC

2016 US Elections

America just held its 58th presidential election, which also coincides with the House and partial Senate and some State Governor elections. Although many were surprised by the results, it wasn't a huge surprise to me. Going into the election, polls consistently showed Hilary Clinton with a slim 3%-4% lead over Donald Trump. Clinton had a bigger 10%+ lead but it fell precipitously after the surprise big-news-turned-into-no-news FBI "bombshell" a week before the election (this clearly deflated a lot of Democrats and independents that were going to vote for Hilary). The fact that Hilary Clinton was already viewed negatively by many neutrals (for the corruption and Libya war and so on) didn't help matters. Results seem to suggest that Hilary's loss was due to supporters not turning up, rather than Trump attracting more. In the end, Clinton ends up with a majority of the votes by a slim margin (mostly due to high votes in populous states like California and New York) but doesn't garner enough electoral college votes which are influenced by states.

As clearly visible from the results below, Clinton lost some key states that Obama had secured. Trump won states such as Florida and Pennsylvania (large # of electoral votes) and others such as Wisconsin, Michigan and Ohio. I think the votes are representative of the struggles faced by many working class and middle class Americans. Many of these states represent the manufacturing heartland of America. For foreigners not familiar, when history books talk about manufacturing advances and developments over the last 100 years, many were in states such as Ohio (Wright brothers & flight), Michigan (Henry Ford & automobiles) and Pennsylvania (John D Rockefeller & oil). These industries have been declining for decades but may have reached the end of their "economic life" in the last few decades (obviously these industries are not going to end but the point is that they won't create jobs and won't increase wealth). Most of these states traditionally voted Democrat but clearly didn't feel that Clinton was going to help their cause. The rapid advances in technology also makes the situation worse for these displaced citizens so the Trump vote is probably a vote against technology as well.

Donald Trump is going to be wildly unpredictable and he is definitely discriminatory against certain segments of the population. It remains to be seen how this plays out. Those in Canada may remember Toronto mayor, Rob Ford, and Trump sort of reminds me of him: someone who is apparently very business savvy (but in reality is not), someone who says anything to get the public to support him (without thinking of long-term implications), and someone with questionable ethics.

The good thing about America is that it has a strong liberal/libertarian-leaning Constitution that is respected by citizens, and largely independent branches of the government (House, Senate, and Supreme Court). The US president has far less power than most people realize! In fact, the Canadian Prime Minister (equivalent to US President) or the British Prime Minister have way more power. Roughly speaking, the US President has less power over domestic activities but has tons of power over global affairs. So, when all is said and done, Trump will likely alter the shape of world politics more than what happens within USA.

The Republicans control the Senate and the House right now so the next few years of political decisions (which generally will impact the next 10 years or so) will be right-leaning. However, the House elections are held every 2 years, and part of the Senate is always up for election every 2 years so any crazy actions by the President usually results in control of Senate and House changing.

The Senate is going to an unusually important role right now because the upcoming Supreme Court judge is confirmed by them. Supreme Court judge rarely changes so this will have a multi-decade impact. On a different note, as the CBC News graphics I captured below point out, the House is the body that can impeach the president, not to mention control the budget. Trump has suggested huge capital expenditures, likely resulting in significant increase in budget deficits, so it'll be interesting to see what the House does.




(Image source: Wikipedia)





(source: "US Elections: Results," CBC News, Downloaded November 11, 2016)

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Saturday, November 12, 2016 1 comments ++[ CLICK TO COMMENT ]++

Warren Buffett on the Wells Fargo Fake Account Scandal

Most of you have probably heard of the scandal engulfing American banking giant, Wells Fargo (WFC). It appears the bank created millions of fake bank accounts under its customers' names. The truth, as always, is never clear but the bank says employees did it under their own will to meet employment goals. Several US government agencies are investigating and the CEO stepped down recently.

Berkshire Hathaway is the biggest shareholder of Wells Fargo (WFC) with about 10% ownership and Buffett personally owns another 2 million shares (worth approx. $100 million right now). But Buffett has not commented about the scandal, until now. In a CNN Money interview, Buffett says he still has faith in the bank and couldn't comment publicly until now because it was a passive investment as stipulated to the banking regulators.




Buffett essentially says senior management made a terrible judgement with the incentive system. It remains to be seen if this is a symptom of the current culture at Wells Fargo or if it isolated and can be cleaned up. I remember Buffett betting heavily on Wells Fargo during the financial crisis, largely due to its culture--he basically implied Wells Fargo wouldn't have made the dumb loans others did.

Some have equated the problem to that of what Salomon Brothers faced when it rigged the Treasury auctions in the 80's. It doesn't seem like the problem is as bad as that. So far it seems limited to a tiny percentage of retail customer accounts. It will only turn into a big issue if there were worse dubious actions involving brokerage accounts and corporate accounts--so far it doesn't seem to involve that.

I don't really understand banks--financials are mostly outside my circle of competence and my investments, such as Ambac, Takefuji, and Delta Financial, were complete disasters--but if you are knowledgeable about them and want a megacap bank, WFC is worth investigating as an investment.

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Tuesday, November 8, 2016 0 comments ++[ CLICK TO COMMENT ]++

Bloomberg's David Rubenstein Warren Buffett Interviews (plus Classic Buffett Videos)

Looks like Bloomberg has a new show hosted by David Rubenstein (founder of private equity powerhouse, Carlyle). He recently interviewed Warren Buffett and it is available online (alt link). It is more of a quick overview and those not familiar with him might learn a few things, but there isn't much new for Buffett fans. But, as always, you always pick up on things that you may not be familiar so it might be worth checking out. I don't follow Buffett as closely as many others and I don't follow Berkshire Hathaway at all so I always learn something new, even if seemingly minor.

For instance, I always wondered why Washington Post shares fell so much in 1974 and it looks like it was due to government threatening to shut down a few of their key assets (TV stations in Florida). I had thought the shares fell just because of the brutal bear market in 1974 but that alone doesn't explain it. I also didn't know Washington Post IPOed a few years earlier. (on a political note, I also finally heard why Buffett became a Democrat in a strong Republican household: it's because of the civil rights).



(source: The David Rubenstein Show, November 4, 2016)


David Rubenstein also interviewed Buffett for the Economic Club of Washington, DC in 2012 (I think). The questions he asks overlap with the prior ones above but some are different.



Rubenstein does zero in on some key questions--such as how Buffett analyzes stocks--but Buffett doesn't really provide any insightful answers. This is one of the reasons I mentioned several years ago that I don't learn anything from Warren Buffett anymore; I have learned all that I can and I need to execute now (student has learned all he can from the master ;) ). I think the reason we never get any detailed steps on how to analyze stocks, or how he came to decide on some stock, or whatever, is because investing is more an art than science.

Asking Warren Buffett how he analyzes a company is like asking Claude Monet how he painted his impressionist paintings, or Stanley Kubrick how he made such good films. There isn't one methodological approach and ideas are synthesized from all sorts of things.


Having said that, newbies not familiar with Buffett should watch his old videos (experienced investors will be already familiar with these). I have linked the best ones I had in my bookmarks and YouTube lists below. Warren Buffett's best videos are probably the university speeches, usually followed by interesting Q&A; the worst ones are the short clips from CNBC (too short and doesn't elaborate on anything).

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Monday, November 7, 2016 0 comments ++[ CLICK TO COMMENT ]++

Purchase: Motors Liquidation GUC Trust (MTLQU)

This was a mistake. Total newbie mistake. If you are a small investor and/or located outside USA, you have to be really careful with commissions and order fills. The investment is also not very straightforward with all sorts of possible outcomes.

The investment is Motors Liquidation GUC Trust units (PinkSheets: MTLQU). This is a tricky investment and I was going to write it up more but because the investment didn't work out--I'll probably break-even or incur a loss for unfortunate reasons--so I'm not going to write much (I don't really have much of a position and don't intend to increase it). You have to do your homework.

Motors Liquidation GUC Trust handles the payments to creditors and other claimants related to the bankruptcy of General Motors (GM). As some of you may know, this is one of the largest bankruptcies in American history (you can read my old opinion on it here) and there were lots of controversies. The company went bankrupt in 2009 but the bankruptcy proceedings are still ongoing. As you can imagine, there are billions of claims that need to be resolved. A trust was set up to handle the credit claims that need to be paid out. The trust units (MTLQU) represent contingents claims. As the Q2 2016 10Q states about the trust units:

"As described in Note 1, under the Plan, each holder of an Allowed General Unsecured Claim retains a contingent right to receive, on a pro rata basis, additional Distributable Cash (if and to the extent not required for the satisfaction of previously Disputed General Unsecured Claims or potential Term Loan Avoidance Action Claims, or appropriation for the payment of the expenses or tax liabilities of the GUC Trust). The GUC Trust issues units representing such contingent rights (“GUC Trust Units”) at the rate of one GUC Trust Unit per $1,000 of Allowed General Unsecured Claims... The GUC Trust makes quarterly liquidating distributions to holders of GUC Trust Units to the extent that (i)(a) certain previously Disputed General Unsecured Claims asserted against the Debtors’ estates or potential Term Loan Avoidance Action Claims are either disallowed or are otherwise resolved favorably to the GUC Trust (thereby reducing the amount of GUC Trust assets reserved for distribution in respect of such asserted or potential claims) or (b) certain Excess GUC Trust Distributable Assets (as defined in the GUC Trust Agreement) that were previously set aside from distribution are released in the manner permitted under the GUC Trust Agreement, and (ii) as a result of the foregoing, the amount of Excess GUC Trust Distributable Assets (as defined in the GUC Trust Agreement) as of the end of the relevant quarter exceeds thresholds set forth in the GUC Trust Agreement."

So, basically, it is a liquidation and you will receive periodic payments.

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Sold: Ingram Micro (IM)

Similar to the reasoning for selling Lexmark, I sold Ingram Micro (IM) after the stock market rallied strongly and the merger arbitrage gap closed significantly over the last week. Three reasons drove the closure of the gap: (i) markets rallying strongly, (ii) Ingram Micro posting strong earnings, and (iii) CFIUS granting approval.

Return isn't high but I'm ok with it given its short time period and uncorrelated return.

Purchase Price: US$35.87
Sale Price: US$38.55

Total Return: 7.4% (annualized: 782% -- meaningless, short holding period)

Good luck to Ingram Micro employees and hopefully the merger will benefit all parties.

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Sold: Lexmark (LXK)

With markets rallying strongly and the merger spread narrowing considerably, I decided to exit my Lexmark (LXK) risk arbitrage position. If I had waited for full closure, I could have earned 1% more with little risk. This was my first purchase in 6 years :( and am very satisfied with the return.

The key reason for the merger gap was due to uncertainty over CFIUS approval, which eventually happened. Most of the gap closed after the approval was announced.

Purchase Price: US$36.03
Sale Price: US$40.12

Total Return: 11.3% (annualized: 134% -- meaningless, short holding period)


Once the merger is consummated, this will end Lexmark as an independent entity. Interestingly, in a similar path to Lenovo, a former subsidiary of IBM ends up in Chinese hands. It is a sign of the growth of the Chinese economy and the rise in prominence of Chinese companies on the world stage. (Having said that, I still maintain my bearish view of China and think it is in a major bubble which is only experienced a few times each century. What's remarkable to me is that I was thought China was in a fixed-asset bubble (i.e. real estate, manufacturing capacity, railroads, etc) but I never imagined it would also end up with a massive credit boom (after 2008).)

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Sunday, November 6, 2016 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle CXCIX

Celebrity Earnings for Social Media Sponsored Posts

"HAVING just received a fancy new watch from TAG Heuer, Cristiano Ronaldo, a footballer, posts a photo of himself, wrist aloft, to his Instagram account. He dutifully thanks them for their “kind gift” and signs off the post with the company’s advertising slogan #dontcrackunderpressure." -- The Economist

(source: "Celebrities’ endorsement earnings on social media," The Economist, Oct 17 2016)

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Friday, November 4, 2016 0 comments ++[ CLICK TO COMMENT ]++

Bloomberg Businessweek's Top 85 Disruptive Ideas in the Last 85 Years

Some of you may have seen this already so it's a bit old but I just ran across it and found it interesting. It may have been at the end of 2014, but whenever it was, for its 85th anniversary, Bloomberg Businessweek published its top 85 disruptive ideas.

Note that this is just the top ideas over the life of the magazine (i.e. last 85 years) so it isn't a list of  the best ideas of all time. Furthermore, the magazine, and hence the list, is US-centric so many ideas that had a bigger impact on the world are missing. Businessweek was also famous for being a business magazine that was more focused on cultural issues, science and technology, and various other topics usually not covered in serious business magazines. There is also lots of recency bias--I wouldn't list Google, Amazon.com, and Al Qaeda so high up on the list. It's also debatable how some items that may have profound impact in the future but haven't produced any major impact presently should be rated (a good example is DNA sequencing, which is ranked at #25, but might have a bigger impact than most of the top 25).

What I like about this list is how it includes all sorts of diverse topics, ranging from business to politics to social science. It has some unusual cultural items that most others wouldn't rank in any of the their lists. It is more thought-provoking than the usual top list. This means that lots of people will disagree with the rankings. For instance, the basketball shoe, Air Jordan by Nike is listed at #45, whereas, say, the development of Black-Scholes formula for pricing derivatives is at #60. I, as well as many others, will rank the formula higher (since the massive derivatives industry would not have grown so big and companies wouldn't have become as reliant if it weren't for the quantification and pricing of such securities).

An eclectic list for sure. If you have time to kill, scroll through the list. I have listed the top 25 with my brief comments in square brackets.

Bloomberg Businessweek Top 85 Most Disruptive Ideas over the Last 85 Years

1. The Jet Engine 1958 Pan Am inaugurates daily Boeing 707 service across the Atlantic. [Definitely a major invention that brought the world closer together. I would put this lower since it is just the jet engine and doesn't refer to the invention of flight which happened earlier.]

2. Microchips 1947 Researchers at Bell Labs invent the transistor, the critical first step toward development of the microchip [I would probably put this as #2. My #1 would be the Internet but it isn't listed as such.]

3. Green Revolution 1965 Disease-resistant wheat seeds developed by Norman Borlaug are intro­duced in India and Pakistan. [Huge impact that is often ignored and not understood by many]

4. Wal-Mart 1962 Sam Walton opens the first Walmart store. Read the story 5. [Probably belongs near the top. Walmart revolutionized American retailing and pioneered the newly invented "big box" store concept.]

5 TV 1934 Philo Farnsworth stages the first public demonstration of an all-electronic television system at Philadelphia’s ­Franklin Institute. [No comment. A major impact on society.]

6. Google 1998 Larry Page and Sergey Brin develop a search engine that ranks Web pages based on how many other pages link to them. [Overrated; maybe would belong high on the list in another 20 years if Google can maintain its dominance.]

7. Junk Bonds 1989 Kohlberg Kravis Roberts uses junk bonds to finance its $26 billion hostile takeover of RJR Nabisco. [Major impact on Wall Street finance, particularly capital structure of corporations. However, should be ranked lower than some of the ones listed further below like credit cards and securization (Ginne Mae 1970).]

8. The Manhattan Project 1941 Franklin Roosevelt approves the creation of a secret program aimed at developing an atomic bomb. [Hard to rank this given how it didn't impact the world in a continuous manner, but it played a big political role in the mid to late 20th century.]

9. The Pill 1960 Enovid is approved by the U.S. Food and Drug Administration as the first oral contraceptive. [Big impact on social behaviour.]

10. Apple 1976 The Apple I computer goes on sale for a retail price of $666.66. [Should be ranked lower.]

11.  Al-Qaeda  1988 Al-Qaeda is formed in Peshawar, Pakistan. [Overrated and should be further down the list.]

12 Global Warming -- 1988 James Hansen, then director of NASA’s Goddard Institute for Space Studies, introduces the idea of “global warming” to the public at a Senate hearing in Washington. [Verdict is still out and it will only be obvious in a few decades.]

13 Venture Capital 1946 Georges Frederic Doriot establishes the first institutional private equity ­investment firm, American Research and Development, to invest in businesses run by World War II veterans. [Should be further down the list. It was an important development but limited in scope.]

14 The Cubicle 1968 Design firm Herman Miller introduces the Action Office II workspace. [Probably should be higher up if you look at cultural impact on corporate life]

15 GPS 1983 President Reagan signs an executive order allowing ­civilian use of the Pentagon’s Global Positioning System. [Important development]

16 Shipping Container 1956 The first container ship, the SS Ideal-X, carries 58 containers from Port Newark, N.J., to the Port of Houston. [Should be in the top 10 or maybe even top 5. The modern global trade system and intermodal transportation would be far less effective without this invention.]

17 Fixed-Rate Mortgage 1933 The Home Owners’ Loan Corp. introduces a 15-year, self-amortizing home loan. [Probably had a bigger impact on the economy than many other finance or economics items listed here]

18 McDonald's 1954 After visiting the McDonald brothers at their restaurant in San Bernardino, Ray Kroc signs on to be McDonald’s first franchising agent, launching the world’s biggest fast-food empire. [Revolutionary development that altered the notion of a restaurant and dining out, especially if you look at in combination with later developments such as the drive-thru.]

19 Credit 1950 Frank McNamara, the founder of Diners Club Card, charges dinner at Major’s Cabin Grill in New York—the first transaction made with a credit card. [Hard to imagine that credit cards started out as restaurant cards]

20 Amazon.com 1994 Jeff Bezos founds an online bookstore in his suburban Seattle garage. [Amazon could turn into a major development but right now, it doesn't deserve to be this high up the list.]

21 Refrigeration 1930 DuPont manufactures Freon, sparking the adoption of residential and commercial refrigeration. [Had a big impact, not just on residential food storage and preparation, but also in transportation of goods, especially meats, across countries]

22 One-Child Policy 1979 After a decade of promoting family planning, the Communist Party of China, under the new leadership of Deng Xiaoping, introduces compulsory limits on childbearing. [Disastrous, although some might argue short-term beneficial, policy that might end up being one of the worst government mistakes in human history.]

23 HTML 1993 The first version of Hypertext Markup Language is released, effectively creating the Web. [HTML in and of itself is hard to rate and probably doesn't rank this high. But if you look at Internet in general, I think it should be #1 on this list.]

24 Perestroika 1986 Mikhail Gorbachev eases government controls on industry and allows workers’ cooperatives to set up private businesses. [Hugh impact on the world. Probably should be in top 5 or top 3. Led to the collapse of USSR, reunification of East and West Germany, independence for Eastern and Central Europe, opening up of China, etc]

25. DNA Sequencing 2000 The human genome is decoded for the first time. [Has had little impact so far but might impact the world more than anything else on this list. Who knows what the potential is but any progress on "science-fiction" concepts like cloning, genetic disease elimination, genetic reengineering, age longevity, and so forth, will have dramatic impact on humanity.]

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Wednesday, November 2, 2016 0 comments ++[ CLICK TO COMMENT ]++

Purchase (Special Situation): Virgin America Takeover

I need to diversify my risk arbitrage positions and took a new position. Unfortunately the returns are low and nowhere near by 10% or so target, but the deal is supposed to close within a few months so I think it's ok.

Alaska Airlines, a Seattle-based discount airline, has offered to purchase another discount airline that was just IPOed a couple of years ago: Virgin America (VA). My opinion is that the probability of success is very high so it seems worth doing it. However, one analyst mentioned the takeover price might be lowered if major divestitures are required in order to satisfy the government so that is something you should be seriously consider if you take a position. If that analyst is correct, it is possible to lose money on this (at current prices) even if the deal closes successfully.

This Bloomberg article is quite good in summarizing the current state of affairs. As usual, if you are interested, you should read the relevant documents filed by both parties (they have a website set up just for the deal). Unlike professional risk arbitrageurs, amateur investors like me often hang on to failed merger companies so if you fall in that category, you should check out that merger website to get up to speed on these airlines.

Takeover price: $57

Deal closing: January 1, 2017

Purchase price: $54.08


Prob (success) = 99%
Return  (success) = 5%
Prob (failure) = 1%
Return  (failure) = -48% ( assume it drops to $28 pre-takeover price, minimum over the last few years)

Expected Return = 4.9%

Buffett's Four Key Questions

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

Alaska Airlines is one of the few airlines with investment-grade debt and should have no problem with financing, which is supposed to include cash on hand, assumption of debt, and new debt.

The real risk is regulatory. Discussions are underway with DOJ and some analysts have said that some landing slots might need to be given up (government wants to maintain competition and ensure low-cost airlines have landing slots, which are valued due to congestions at some major airports). One analyst says buyout price might be lowered to $50 if major concessions required.  I'm just a total newbie with these things and this is the first time I heard of something like that (I have seen deals being renegotiated due to economic conditions or company business deteriorates but not when the risk is known going into the deal). If a lower price scenario is true, this is one of the risks here and it may be possible to lose money even if the deal closes (it seemed unusual and unlikely so I went ahead with this position).

Finally, a consumer lawsuit challenging merger is being heard by judge in December or January 2017. I think if the DOJ clears the merger, the consumer lawsuit will probably be dismissed quickly (after all, if the DOJ  investigation will look at most of the issues related to antitrust issues and competition concerns so that should address the issues raised.)

This deal makes a lot of strategic sense for Alaska Airlines so I can't seem them trying to back out of it. Alaska dominates the west coast and Virgin is mostly on the east coast. The cross-America flight is lucrative, not to mention popular between major cities, so this merger is strategically very attractive.

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

Merger parties expect deal to be completed by January 1, 2017. The lawsuit by a few consumers being heard by judge could be as late as January 2017. Required divestitures may delay things. Worst case is probably end of Q1 2017.

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

This is one of those situations where a better deal may come. It may not happen right away but Virgin Airlines is a fairly well-run discount airline with good brand and strong consumer ratings.

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

One downside to this deal is that the downside is fairly large if the deal fails. Pre-takeover price and the minimum price over the last few years is around $28, which is about 48% below current price. There will be a massive loss if the deal fails. The downside is large because the takeover offer price was very favourable. What this means is that shareholders are more likely to be receptive to the deal--in this case they already voted and approved--and hence the probability of success is much higher. In other deals where the takeover premium is low, which often makes it look like bidder is buying the company cheaply, often can be derailed by shareholders voting against it, or major shareholders challenging the price, and so forth; that's not the case here.

I will likely hold the shares if the deal fails since this appears to be a good airline. It has high consumer ratings, is growing revenue, has a modern fleet, and has access to some valuable slots in major US eastern airports. Airlines were terrible businesses but it appears the industry has been profitable over the last decade (the Alaska Airlines presentation on the merger suggests that the super-long-term terrible performance of the industry may have ended: their slide 9 shows the industry having lost $52 billion between 1977 and 2009, while earning $45 billion between 2010 and 2015). Who knows for sure, but one thing is that government-owned national airlines have mostly disappeared and this has likely improved the industry (government-run airlines in the past were not profit-oriented and were run at losses and uneconomic decisions were the norm). Furthermore, the decline in travel costs, largely due to low-cost carriers, fuel efficiency improvements, and information technology adoption, has also resulted in more people travelling, hence improving utilization rates and industry profitability. Some recent changes by airlines, such as charging for checked-in luggage, has generated additional revenue for them too (but not sure if this is going to blowback in the future). This is still a capital-intensive industry and not an ideal investment but appears much better than the past.

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Quick Thoughts on Amazon

I haven't been following the markets, nor investing for about 3 or 4 years, and it is interesting to see how things have changed. Not sure if any long-time readers are still around but some may remember that my favourite company (from a business perspective) was Amazon (AMZN). It was always seemingly too expensive so I never invested in it but if the valuation was lower--say during a stock market crash--I would have no problem investing a large sum for a long time (big risk with Amazon is management risk--loss of Jeff Bezos would be a big negative). Amazon changes more than most other companies of its size so there has been quite a few changes over the last 5 years or so.

First, the Kindle (or tablet in general) does not appear as lucrative or revolutionary as many investors, including me, imagined. I always thought Kindle had too much hype but I thought tablets as a category finally reached the stage where they could be used as a reading device. Obviously this didn't happen; some hardcore fans still use Kindle for books, but a lot of people, including me, don't use it as our primary reading device. Competitors like the iPad have also done poorly and personally speaking, I feel it is too limiting and lacking innovative features. For instance, it's hard to type up a blog post on the iPad, and don't even think about trying to download/edit photos (beyond something very basic) from a camera or something.

AWS (Amazon Web Services) has grown much larger within a few years. Cloud computing and web services seemed uncertain a few years ago but has now gained wide acceptance. Amazon is clearly a leader and will remain one of the top companies in this space for decades. Their lead is fairly large and, in addition, network effects and economies of scale keep strengthening Amazon's moat every single day). Having said that, it's not clear how good the web services/cloud services economics are. I think the market is attaching too high a multiple on anything cloud-related. Good example is how the market has bid up Microsoft (MSFT) largely on its perception that Microsoft is, all of a sudden, a cloud and web services company and profits are going to be great. The big question is whether the industry will generate commodity-like returns or something much better. SAAS (software as a service) might be able to generate high returns but not so sure about IAAS (infrastructure as a service) and PAAS (platform as a service). Overall, AWS is going to be a big competitive advantage for Amazon but not sure how much it will contribute to profit in the long run.

Another big development is Amazon's push into logistics. Amazon became a fairly sizeable cargo airplane operator recently, after leasing 40 airplanes. This is in the very early stages but if Amazon could make this a success, it will radically transform the company and significantly reduce shipping costs and, perhaps more importantly for the future, shipping time. Quicker shipping time would be a big service differentiator.

Finally, I notice that Amazon sort of has some Costco-like characteristics: the Amazon Prime membership. A few years ago Amazon Prime was mostly a shipping thing. If you wanted faster shipping and/or cheaper shipping (if you ordered a lot of items), it was something to consider. Quite a number of people who signed up for Amazon Prime cancelled it after a while. Over the last few years, Amazon has bundled certain additional features/services, such as free online movies/television shows. This has resulted in many customers signing up and remaining recurring customers. It's almost like an optional membership now. The interesting thing is that the financial characteristics resemble Costco in a minor way now. Costco competed with discount retailers like Walmart but its membership fees generated guaranteed revenue every month. Based on some estimates, Amazon has about 54 million Amazon Prime customers. At around $100 per year ($99 but let's just round it up for simplicity sake), that means Amazon is earning around $5.4 billion per year just on Amazon Prime memberships. That has to cover shipping and other services that are bundled, but it means customers are likely to be sticky. Similar to Costco members, Amazon Prime customers are likely to consider Amazon as their primary shopping destination and spend more at Amazon.

Overall, the company looks overvalued just like when I last looked at it briefly. But it has executed well and its moat is significantly larger. I also like how the company, through luck or foresight, has diversified into adjacent businesses.


(On an unrelated note, one other subtle change over the last few years I notice... that impacts small investors is how trading commissions have gone down significantly in Canada (USA was always cheaper and hasn't dropped as much). It used to cost around C$25 to place a trade--less if you traded a lot or had some premium account--but now it is around $10. If you portfolio is small, this is a big change for things like risk arbitrage. Before a "round-trip" buy/sell would be around $50 so if you invested, say, $5000, that's like 1% cost. Now it is less than half that so risk arbitrage positions with small spreads can actually be considered.)

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