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2 new postions: HHC and KSP

December 14, 2010

Over the past month I have opened 2 new positions. I have been waiting to lay out the rationale behind each until I could build it to a sufficient size, but the markets have been unfavorable to me in a favorable kind of way. As soon as I stuck my toe in the water and purchased an initial position, the share price began to trend higher, enough so that I’m afraid I may end up never taking a full position in either of these two stocks. Instead, I may be forced to flip the shares for a short-term gain, much to my dismay.

 In the name of investing discipline I’ve made a few rules to help me get into positions. They go something like this:

I generally like to buy into a position in back-weighted thirds. If a stock hits my initial share price target, I buy my first 3rd (which is really 1/3 of the eventual minimum $ position I want as a percentage of my total portfolio). Then I expect the price will go down. Yep, my buying shares in a company is generally a signal for all you other stock mavens out there to sell. So if the share price goes down a minimum of 15% (but I usually hold out for 20%) then I buy at least the same dollar amount of shares in that company (which translates into 17-25% more shares than the first tranche). Then, if and or when the share price declines another 15 to 20% I buy my final 3rd, again, a dollar amount the same or greater than the first two tranches. The problem arises when other investors out there don’t get the email that says I’m buying and they don’t dump the shares they own, so the price never goes down. Even, horrors, the price actually begins to rise. What to do with these orphan positions where the share price level never gets to my second or third tranche target? Well, my general rule is (assuming nothing changes at the underlying company) that if the share price rises 40% within the first 3 months after  investment (rather than falling 15-20% like it should), I deem that the price is unlikely to  quickly fall back to my investment target level, and thus I sell the orphan position. If the price remains within the band between 20% and 40% of the initial investment after 6 months then I sell. With an advance less than 20% I retain the position in the hope that the share price will retreat to my 2nd or 3rd purchase level target, and thus continue to hold.

 OK so much for theory. These were my recent purchases.

The Howard Hughes Company (HHC): I wasn’t really following the General Growth Property bankruptcy saga primarily because I don’t do distressed debt but also because it seemed far too complex a situation and many better minds that mine were focused on it. I had written myself a note early this Fall to review HHC when it was spun off as it looked like an unloved orphan, and I generally love those. In November I saw HHC mentioned on one of my favorite forums, The corner of Berkshire and Fairfax, and one commentator listed HHC’s primary real estate holdings. The one thing I remember reading was that the South Street Seaport in NYC is on HHC’s books at the original cost of $2.8 million (could it possibly be?) when it is obviously worth more, much more, maybe even 100x that. A quick check of HHC on Yahoo finance showed a book value close to $41/share. The stock was then selling at about $41/share. So I though “Hmm… if the South Street Seaport is on the books at less than 10% of market value, then maybe there’s some other hidden real estate value on the books and this thing could be selling at a fraction of private market value.” I downloaded the latest 10Q, some of the bankruptcy documents and went searching for the CS First Boston analysis of HHC assets done prior to exiting bankruptcy. But, I thought to myself, “I’m going to really have to get myself motivated to read this mass of data so, maybe a little skin in the game?” Yep, I purchased a small position without too much homework. And I began to read through all the reports and documents. I don’t know if this was the reason, or it might have been the after-effects of my niece’s delightful if somewhat drafty and damp wedding hall, but my facial neuralgia flared up and a less than delightful cold ensued (more info than you wanted, huh?) so almost a week intervened. When next I looked, the share price had climbed into the upper mid $40s range (well above my next trigger point of $38) and, since then, has continued on an upward trajectory each ensuing day. Perhaps it was helped by the early December disclosure that Pershing Square not only continues to hold its position in HHC inherited through its ownership of GGP but it has augmented its holdings. The shares are now in the mid 50’s and showing no sign of slowing down. I’m disappointed, and I’m not spending any more time on the analysis until the stock price falls into my target area (why, you ask? You don’t even know what the intrinsic value is if you haven’t finished your analysis, you might say, and you would be very right! But we all anchor on prices…). The truth is, my quick read through of the documents garbled my original simple investment theory, yeah the one about the South Street Seaport, and I have come to believe that I don’t have enough real estate expertise to determine the intrinsic value of this company. So this one is really outside my competence. Furthermore, after a bit of reflection I have to conclude the company is really outside the parameters of my investing strategy as it has a market cap now over $2 billion. My limit is usually $1 billion. So I’ll keep my initial position until it goes up maybe 50% or more and then sell out for a tidy little profit and hopefully find something more suitable for my wardrobe… uh, no I mean portfolio.

 My other new position is in K-Sea Transportation Partners LP (KSP). This was more of a contrarian bet, or a ‘regression to the mean’ investment. Like BBEP KSP is a broken Limited Partnership. The only difference is that KSP actually needed a white knight, and paid dearly for it, while BBEP made it through without having to mortgage their (read the shareholders’) underwear. I was introduced to KSP on the abovementioned Corner of Berkshire and Fairfax forum. There was also a nice little writeup on VIC, I think last May.

 Background from Yahoo Finance: “K-Sea Transportation Partners L.P. provides marine transportation, distribution, and logistics services for refined petroleum products in the United States. As of September 1, 2009, the company operated a fleet of 69 tank barges and 66 tugboats, which offer services to various customers, including oil companies, oil traders, and oil refiners. K-Sea General Partner L.P. serves as the general partner of the company. K-Sea Transportation Partners L.P. was founded in 1959 and is headquartered in East Brunswick, New Jersey:”

 The company ran into liquidity problems at the end of 2008 and early 2009 like many other leveraged companies and especially Partnerships. Units of KSP that had traded as high as the mid $40s in 2007 fell to $15 in November 2008. The dividend payout, however, continued unabated and was even increased for the last 2 quarters of 2008 to $.77/unit and there it was maintained through the first 2 quarters of 2009. Unit prices, like the rest of the stock market, rebounded through the 3rd quarter of 2009 rising into the mid $20s. But the liquidity problems at KSP persisted and the payout was cut to $.45/unit for the 3rd quarter of 2009 (paid in the 4th quarter) and eliminated thereafter. With the payout elimination the unit price tumbled and then gradually declined further throughout 2010 as the liquidity situation worsened, reaching $4 in July. In August a deal was announced to inject $100 million into the LP. Unfortunately for existing unitholders the terms were, to say the least, extremely punitive. This was clearly a case where the interests of management were not aligned with those of shareholders! New preferred units (18.4 million) were issued for the $100 million, sold to a partnership of Kayne Anderson Capital Advisors and First Reserve, on top of the existing 19 common units. To add insult to injury, the new preferred units carry an interest rate of 13.5% payable in kind until cash distributions can be reinstated. Thus existing common unitholders are looking at 50% dilution at minimum! Ouch. Needless to say units sold off on this news and sold for under $4 in October before 3rd quarter results were announced. Once the favorable 3rd quarter operating results were announced, though, the unit price rallied to over $5 a share.

 So here was my thinking. Back in October, prior to operating results being announced, I was readying to buy into  this LP under the theory that the new investors would protect their investment on the downside if more liquidity was needed and thus a total wipeout for the common unitholders was improbable, even if theoretically possible. The new investors were going to eventually exchange their preferred units for common units on a 1 for 1 basis and thus have an effective cost basis of $5.43/unit. So I figured that if I was able to get in around $3.50-4.00 per unit I would have some margin of safety. see below for details. Unfortunately, I was a little slow or greedy, waiting for a price on the low-end of my target range, and the earnings release took me by surprise. Since earnings were significantly better than expected, the units rallied to over $5.00 a share and at that point I thought, my window of opportunity had closed. Operational results made the investment more attractive but a price of over $5.00 a share was just too close to the effective price of the price paid by the extortionist White Knight. Instead, year-end tax selling brought the shares back into my target range despite the up market. My first tranche was bought at $4.53. However, instead of falling further, the units have now rallied to over $5.00. Where are you tax sellers? I’m looking to complete my position in the low $4s… now appearing less and less likely.

 My investment thesis was/is this. Prior to the financial meltdown in 2008, KSP was generating distributable cash flow of at least $.77 unit per quarter. Let’s say that the partnership is able to generate 80% of this in 2 or 3 years time. Given that there will be at least twice as many shares (and potentially more depending on when cash distributions are reinstated) after the conversion of preferred units, that would get us to between $1.00 and $1.25 per unit in distributions. Let’s say investors would need a yield of 10% once the operations of the partnership settle down. We would be looking at a price of somewhere between $10 and $12.50 (depending on the eventual dilution) per unit. I generally look for a 2x upside to 1x downside equation. So at $4.00 a unit I am solidly within the optimistic scenario. I was really hoping to get in at $3.50 so that the thesis would work even with the pessimistic scenario, but… doesn’t look like it unless a big holder unloads in these last couple of weeks.

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From → Positions Closed

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