I hate to say it but I liquidated my position in Gazprom (OGZPY) after just 2 months and a 25% gain. Ouch! I hate trading in an out of a position so quickly, but when something goes up 25% in 2 months I feel like lady luck has smiled on me and its time to take a little money off the table. Especially since my conviction level for this investment was pretty low. In any case I may repurchase the position if the share price dips or the investment climate in Russia improves.
I’ve recycled the proceeds from my sale (plus a little more) and taken a position in Oil States International. It’s a company in which both Greenlight and Jana Partners have had an activist position for the past several years, and management finally agreed to the activists’ spinoff strategy; the company will spin-off its lodging component at the end of May (May 30 expected distribution with a record date of May 21). Actually, to all effects, the company is splitting in two: an oil and gas exploration and production company and a lodging company (Civeo) serving the oil and gas and mineral extraction industries. Each will be about the same size revenue-wise. The lodging company is exploring the possibility of becoming a REIT, probably not until 2015. In the meantime it will be paying a small dividend. This is a classic situation where management is untangling a ‘conglomerate’ that appeals to two different types of investor. I think Einhorn/Rosenstein are right that value of the sum of the parts will be greater than the current whole. You can read about the spin-off here. I won’t go into the specifics but I am looking for a 20%+ return for a 6 month to 1 year investment.
Ever since watching this video of Wilbur Ross speaking at the Ivey School of Business I’ve been thinking about what makes a good value investment, and I’ve come to the conclusion that:
- any true, i.e. deep, value investment has to entail the possibility of a 3x or greater return (note that I’ve jus pulled ‘3X’ out of a hat; what I really mean is that one has to think in multiples of the current market price not 2 digit percentage returns),
- in order for multiple return potential to exist, either the company, the industry or, hopefully, both have to be in some sort of stressed situation,
- the key to identifying ‘stressed situations’ is to go only where no foot is currently treading.
You can see this kind of thinking reflected, but without the rationalization, in Walter Schloss’ simple but tried and true approach to investing where his first level filter is the list of new weekly lows. Now, this approach doesn’t exactly identify stressed situations on an industry basis except indirectly, as market prices tend to reflect the level of ‘stress’, but in some sense it’s doing the same thing in an oblique, company-specific way.
Why have I been thinking about this? Well, obviously because I’m looking for the next great investment, but also because I’m trying to explain to myself why I haven’t been able to find those great investments over the past year. The short answer is NOTHING SEEMS TO FEEL LIKE A STRESSED SITUATION in this market. I think one of the reasons is that the lake of liquidity that has pumped up the market from its 2009 lows is supporting just about everything. We haven’t really been in a stock picker’s market since before 2008; simply everything, the turds as well as the cruise ships, have been floating ever higher on the increasing tide. There will necessarily come a day when the tide stops coming in, and on the ebb we may see some value opportunities as we did in 2008/2009. I’ve been wary of this market for the past couple of years on this count and my performance has really suffered; Despite my largest position being in AIG which has floated upward admirably with the tide, I have lagged the market. Part of my underperformance can be attributed to my significant cash position, but part is because my deep value investments have not really kept up. Oh, and then there is the small issue of Fortress Paper, an ill-conceived because ill-timed investment. My definition of ‘deep value’ on that one was simply wrong. However, had I waited until now when it has really become a deep value play I might have been OK. I was just dazzled by the seeming opportunity and FORGOT ONE OF THE CARDINAL RULES OF INVESTING; DON’T INVEST IN SITUATIONS THAT DEPEND ON COMMODITY PRICES. They are simply not predictable and there is almost no ‘margin of safety in such company shares.
So where does this line of reasoning lead, in terms of searching out new investments? Like Wilbur Ross I need to look only at sectors, or individual companies, where the stock market value has collapsed, when everyone is running away, dumping the shares, saying there’s no chance for this company, no future, get out now while you can still get a few cents back on the dollars you invested! Unfortunately there are few of them around at the moment. Perhaps the mining sector….. and thus the investment in Altius Minerals. Perhaps Russia with all this Ukrainian thing going on. (By the way, we have the Monroe Doctrine which let us invade a bunch of Central American and Caribbean counties over the years… did we expect that Russia wouldn’t follow the same kind of logic? but I’m getting off track)… so thus the starter position in Gazprom. But even in these two instances the valuations are not really stress valuations. So I’m turning to another of Greenblatt’s favorite areas, spinoffs. There are a number of recent and upcoming spinoffs that look somewhat promising. Now if some large pension funds would just begin to load up on AIG stock and bump the price another 10% or so, I’ll be able to begin selling down my position and free up some cash.
I’ve just sold my smallish position in Sandridge Energy at $6.95. I hit the 1 year, long-term capital gains holding period threshold, and with the shares up over 40% and no asset sales or buyout in the public domain I can no longer justify maintaining the position. My original investment thesis was that the shares were significantly undervalued due to 1) the former management’s aggressiveness resulting in a heavy debt load, 2) an unexpected continued weakness in the price of natural gas, 3) Mr. Market’s skittishness as regards to SD’s share price as it had fallen 80+% over the past 5 years and 4) my belief that the new management would quickly sell off assets or, preferably, the whole company. Unfortunately the catalysts on which my thesis was based have not really materialized. The company has reduced debt by selling off assets, but at a much slower pace than I had hoped for, and a sale of the company does not now seem to be in the offing. Natural gas prices have firmed up somewhat, but not as much as Mr. Market anticipated, with the result that gas producers have not been revalued upward as much as I had anticipated. As I have no particular competence in valuing Oil & Gas E&P companies, I really can’t determine whether SD continues to be significantly undervalued. Thus it was time to sell. I bought at a time when it appeared to me Mr. Market was valuing the company based on a worst case scenario, at a fire sale price. There was no need to be precisely right about the valuation. Any positive event was bound to make Mr. Market revalue the company. So even without the most positive of outcomes for my investment thesis, a sale of the company or a significant jump in natural gas prices, the company has been revalued upward by some 42%. I am content with that result as I look into other potential investments that appear to have a clearer discount to intrinsic value.
I’ve been remiss in blogging about my investments this first quarter. My only excuse is that there really wasn’t much to blog about. The market has remained high and I haven’t found many good opportunities for my Value portfolio. I did add to my position in Fortress Paper when the earnings came out and the shares dipped. I also added small positions in both Altius Minerals and Gazprom about 3 weeks ago when shares in both dipped toward 12 month lows; in the case of the former I’m not sure exactly why, though for Gazprom it was the impact of the Crimea episode.
My largest position by far continues to be AIG. The share price has lagged the market over the past quarter, declining some 3% YTD, due to disappointing 4Q earnings. I think in general everyone had expected that returns on assets/equity would continue to revert to the mean (in this case upward) much faster than it actually has. Patience is the key here. The shares appreciated more than 40% in 2013, considerably more than the overall market, so a short breather is probably in order. I continue to believe ROE will eventually begin to creep upwards again and the market should reward the shares. In the meantime the dividends continue to grow.
My bank of America warrants, on the other hand, performed admirably in 1Q, with the warrant price increasing over 25%, cleanly besting the S&P 500’s 1% gain. Other winners for the quarter included NovaGold, up 40% on a small rebound in gold prices and Resolute Forest Products up over 20% on better than expected 4th quarter results. And, while Fortress Paper shares were down for the quarter, I did load up, increasing my position 50% when the share price swooned to around $2.50 around the earnings release. So, all in all, the performance of my position did much better than the share price.
Other events relating to portfolio companies:
1) Peter Kellogg has effectively taken control of MFC Industrial. Following an agreement just prior to the contested proxy vote at the annual meeting in December that resulted in two board seats given to Kellogg representatives, things have evolved further, with Kellogg subsequently being elected Chairman of the Board and Michael Smith announcing his retirement from an operational role at the company by the end of this year. There have also been two significant acquisitions (which I assume were Smith’s doing) in Q1 that finally put some of the company’s idle capital to work. Let’s see if Kellogg can get the company assets to generate the kind of returns we investors have been waiting for. I’m wondering whether some or all of the Compton Petroleum assets might now be disposed of as natural gas extraction doesn’t really seem to fit in with the MFC’s stated corporate mandate. Though opportunistic and outside the company’s main line of business I do think the Compton acquisition could still prove to be transformative (perhaps in the context of a sale).
2) Steel Partners announced a dutch tender for $49 million worth of units. This is a minimum of 9.1% of units outstanding if the final tender price is at the high end, $17.50. I can tell you that I won’t be tendering (and neither are any of the owners/officers of Steel Partners) as I continue to believe the units are trading for about a 40% discount to NAV.
3) I had almost decided to up my position in RadioShack (shares were trading around $2) when it was announced that Litespeed had taken an 8% interest. The result was a quick 20% uptick. But after a month, the shares are back down around the $2.00 mark. I may take another look soon.
As to my two new additions, Gazprom and Altius Minerals, I’ll have to work up a separate post for each if and when I decide to make either more than just a small starter position.
As I was looking around the investing universe for possible underpriced securities over the past couple of months I happened upon a number of closed-end funds trading at significant discounts to net asset value (NAV). Now, usually I wouldn’t consider these appropriate for my ‘value’ portfolio as the upside potential is generally in the single to low double digits percentage-wise, mostly from a narrowing of the discount, plus there needs to be some kind of catalyst to make the discount disappear. Furthermore, in my experience CEFs trading at a discount are more a phenomenon of bear markets rather than bull markets. Last year, however, a number of fixed income CEFs began trading at significant discounts to NAV after the tapering announcement in June by the Fed sent the bond market South. This included not only municipal income CEFs but also funds invested in mortgage securities. The discounts widened to almost double digits in December as investors with significant taxable gains in equities looked to offset those gains with something, anything, in their portfolio that was trading at a loss. Barron’s highlighted this at the beginning of December (not exactly a secret source). I did take a position in a couple of these CEFs in another portfolio, and so far the funds have done well, rising 4-5% in January. However, this was pure chance because the thesis that the discount would narrow has been proved WRONG, at least to date. If anything, discounts have widened. But the funny thing is, NAVs have increased even more, more than offsetting the growing discount. So you see, you can be wrong and still make money, or, another way of looking at it is, you can’t tell if you’re right with your investment thesis just because you DO make money. Beware of false positives!
So what does this have to do with the little riddle in the title “when is a discount not a discount”? Nothing yet… What I wanted to bring up, after my first point above, is that CEFs can be tricky little buggers. They don’t always do the things they are supposed to do. I’ve been following the Special Opportunities Fund, a closed end fund managed by Bulldog Investors, because it follows a strict investment strategy in a little sandbox all its own, i.e. taking advantage of CEF discounts through activist investing. Generally they invest in closed end funds trading at a discount then try to get management to take some action, like a share tender, that will narrow the discount. They have been quite successful over the past 20+ years and have outpaced the indexes by several percentage points a year. I have been keeping an eye on the fund because it has been trading at a discount to NAV recently and I had been thinking of investing. Wow, a discount on top of a discount! Sounds interesting…
My balloon was punctured this week. The discount I thought SPE was trading at was really not a discount at all. Last Friday (1/24) the fund closed at $17.11 per share and the reported NAV was $18.54 for an apparent discount of 7.7%. Monday the Fund announced that it was redeeming its convertible preferred shares in March for those who don’t convert beforehand. The fund shares immediately tanked over 5% (and have continued down since). Huh? Convertible preferred shares? Who knew? Because the converts are trading at a premium to face value (because if converted they are more valuable than their liquidation value) but are accounted for only at liquidation value in the NAV calculation, the conversion will result in dilution of the total asset value and thus the NAV per share. I’m assuming, of course, close to 100% conversion because only someone on mental vacation will trade in a preferred share trading over $60 for its $50 liquidation value. So dilution from the convertible preferred will result in the per-share NAV declining close to 7% for the common, and there goes the discount to NAV that appeared to exist last week. Now, I’m not exactly sure why they chose to call the convertible preferreds now, except that perhaps they didn’t want the apparent discount to NAV to grow and create some future shareholder issues. But it just goes to show you that you need to read the fine print when dealing with closed end funds. And I still consider Bulldog one of the most upfront of closed end fund managers.
PS. SPE’s annual and semi-annual reports are a good source of investment ideas for those interested in some arcane securities.
This is the first in my series of reviews about each and every portfolio holding. I’ve started with Steel Partners (SPLP) because the unit price is approaching the sell target established when I began accumulating units in the second quarter of 2012. Now that we’re approaching that target price should I be selling or has the intrinsic value of the holding company increased such that I should continue to hold?
In looking back over my prior posts on SPLP I realize that my last look at the partnership was dated November 2012. There have been some structural changes at SPLP in the interim, primarily acquisition of an equity interest in Moduslink in March 2013, disposition of an interest in an English insurance company, Barbican Holdings, and consolidation of one partially owned subsidiary, BNS, into another, Steel Excel. Additionally, a number of purchases and sales of subsidiaries have been made at Handy & Harman, a 50%+ controlled subsidiary. So, movement has been both toward simplification of the partnership structure as well as opportunistic purchase and sale of assets. But what we are mostly concerned with is the change in the value of the underlying assets and to what extent this has been reflected in the market price. Have the partnership assets increased in value and has the market price reflected this?
When I first made my case for SPLP my reasoning went as follows: “My investment thesis for SPLP is rather simple. I bought units at about 70% of their net asset value and got the management of a very successful activist investor, Warren Lichtenstein, as part of the deal.” I valued the NAV of the partnership’s underlying assets at about $17.35 per unit and was able to purchase units for an average price of around $11.65. In November of 2012 I upped my per-unit estimate of NAV to $18.40 based on additional information and increases in the market value of partnership investments, and targeted a sale price of around $18 for my units. With the year-end 2013 price at $17.35 have we now reached full value and should I sell?
To answer this, I’ve laid out my most recent valuation below. Note that full-year 2013 numbers are not yet available so the analysis may be somewhat deficient, but because many of the partnership investments are publicly traded we have some pretty fresh data for many of the pieces of this sum-of-the parts valuation.
| % own | Shares | Price | Value (mil) | ||
| Consolidated entities | |||||
| SXCL | Steel Excel | 51.2% | 6,611.9 | $29.51 | $195.1 |
| HNH | Handy & Harman | 54.3% | 7,228.7 | $24.21 | $175.0 |
| DGTC | DGT Holdings | 59.2% | 2,365.4 | $15.83 | $37.4 |
| WebBank | 100% | $45.0 | |||
| Equity method investments | |||||
| COSN | Cosine | 48.6% | 4,963.6 | $2.07 | $10.3 |
| Fox & Hound | 50.0% | $23.5 | |||
| MLNK | Moduslink | 27.1% | 16,041.2 | $5.72 | $91.8 |
| SLI | SL Industries | 24.1% | 994.8 | $27.10 | $27.0 |
| SP Liq. Trust G (China) | $6.2 | ||||
| SP Liq. Trust H (Japan) | $4.5 | ||||
| SP Liq. Trust I (other) | $0.5 | ||||
| Available for sale investments | |||||
| GY | Gencor | 7.1% | 4,181.0 | $18.02 | $75.3 |
| JPST | JPS Industries | 39.3% | 4,026.7 | $6.00 | $24.2 |
| API | API Group | 32.4% | 24,835.9 | $1.23 | $30.5 |
| NATH | Nathan’s Famous | 445.5 | $50.41 | $22.5 | |
| Other | $6.4 | ||||
| Other | |||||
| Handy & Harman note | $21.6 | ||||
| Handy & Harman warrants | 406.3 | $14.53 | $5.9 | ||
| Cash | $35.1 | ||||
| Total Value | $837.6 | ||||
| Units outstanding (in millions) | 29.655 | ||||
| Est. NAV per unit | $28.24 | ||||
| Price per unit | 17.35 | ||||
| Discount to est. NAV | 38.6% | ||||
The major changes since my 2012 valuation have been the revaluation of the Handy & Harman share price, the ModusLink investment and my revaluation of the value of the Webank subsidiary based on the last two years of operating results. Of course, the estimated cash on hand at the partnership level is just a guess and may be off significantly (I await the annual reports to calculate a more accurate figure). Furthermore the number of units outstanding has been going down over the past quarters as the partnership has been repurchasing them; the latest count is from November, and by year-end this may have been reduced by more buybacks. Additionally it should be noted that the partnership announced a further $5 million buyback approval after the last annual meeting in December. While the buybacks have not been substantial enough to close the market discount to NAV for the units, they are certainly a move in the right direction.
Based on the above valuation, the current discount to the underlying asset values reflected in the market price seems to have increased rather than narrowed over the past year. I’m not particularly unhappy with this, however, as it has been caused by a revaluation upward of the asset values while the market price has somewhat lagged. So I will continue holding, hoping that WL will continue to ‘share the wealth’ and not pay himself more than other ‘partners’. Oh, by the way did I mention that the unit price increased some 47% last year, besting the S&P 500 index by over 15%? Now if just all my other investments followed the same script……
Each year I try to do this same post. This year the answer is simple: Just about everything went wrong! My value portfolio, what I write about here, was up a measly 5% when the overall market was up over 30%! The only word to describe this is pathetic. OK, so now the humiliation is over, let’s dissect what exactly happened.
For starters my overall portfolio positioning was wrong. I took a macro view (something I have to keep reminding myself not to do) that the market was overvalued at the end of 2012, and thus I held a large cash position of 25%+ as well as S&P 500 puts throughout most of 2013. This was a drag on my returns, but not necessarily the cause of my egregious underperformance. That can be largely attributed to my choice of investments.
My largest position, AIG, was up a comfortable 45% or some 15% more than the S&P 500. So how did I screw up? Three countervailing losses; Fortress paper (down 50%), NovaGold (down 43%) and, of course, the S&P500 puts (100% loss). Furthermore, my second largest position at year-end, Bank of America warrants, was up only 19% in 2013 and my third largest position, MFC Industrial, was down 6%. So what are my conclusions? and what should I do for 2014?
- No macro positioning: There should be no macro slant to my portfolio. I don’t know whether the market will go up or down in 2014 and therefore I should take no position that depends on market direction, i.e. no puts or calls on the indexes. By year-end I plan to be 90%+ invested.
- I have a number of deep value plays that could take time to work out (MFC, Fortress Paper and Resolute Forest Products fall into this category). Perhaps I am ‘trying too hard’ and need to find investments that fall into the category of ‘shooting fish in a barrel’. It’s time to reassess my investment rationale for each of these positions in light of potentially ‘easier’ investments.
- It is also time to reevaluate my stock picking skills; perhaps they are not as good as I thought they were. I have been reading Quantitative Value by Gray and Carlisle and am considering a change of strategy back to a more probabilistic portfolio construction approach such as they propose. However, with the market at or near all-time highs and the possibility of a decent sell off this year, I will not be making the change until there is a market pull back of at least 20%; quantitative value approaches tend to have significant drawdowns during market retreats. (but am I gaming myself on market timing here?) Also acknowledging that one’s investing abilities are below average is a hard fish to swallow! Might take some time to digest this one.
So, concretely, what are my first steps for the new year? I think I will just be looking to harvest my portfolio further, especially reducing my stake in AIG opportunistically if and when shares begin to trade above 80% of book value ($55). I am looking to be out of that position entirely if shares were to trade between 90-95% of book ($60-65). Further, I will be reassessing each and every other position I have over the next couple of months to see whether we are near my estimate of intrinsic value (revised from when I first made the investment) or whether management simply is incapable of realizing what I thought was intrinsic value (MFC???).
Forgot to post that prior to the end of 2013 I did end up selling off some 15% of my position in Fortress Paper (for a sizable tax loss), as well as adding further to my Gravity Ltd. (GRVY) at $.91 per share. The reasons are those I posted before, but I just wanted to close the circle.
Next post: year-end round-up
I wrote in an earlier blog that I would likely exit my position in Ebix if the company had not repurchased shares in the 3rd quarter following their announcement of a $100 million share repurchase program. They apparently did not repurchase any shares, and with end-of-year short covering lifting the share price above my average cost I thought it prudent to sell all my shares. The rationale is that I can’t find a satisfactory reason why there were no repurchases made. My thinking goes along these lines.
They announced a $100 million share buyback in June after the cancellation of the Goldman Sachs buyout. The company had around $35 million in cash at month-end June. The share price drifted between $10 and $12 during the 3rd quarter. At an average price of around $11 a share, if the company used all of that cash (not a completely plausible scenario, but perhaps by adding a bit more leverage…) they could have repurchased 8% of shares outstanding and increased EPS by 9%. So why didn’t they repurchase any shares? The possibilities are many but let me lay out my thinking.
- They never intended to repurchase shares in the first place, they just wanted to announce something positive to counteract the negative announcement of the GS deal falling through. This in itself should be reason enough for me to sell, or
- They intended to repurchase shares but something happened subsequent to the announcement that prohibited the company from repurchasing shares, such as having material inside information (say, regarding the SEC investigation), or
- They intended to repurchase shares but something happened subsequent to the announcement that made management change their minds. This could have been a negative change in the outlook on the company’s operations, the possibility of a better return from another acquisition, an increase in the uncertainty surrounding the SEC investigation or an increase in the estimated settlement costs related to the SEC investigation.
Only the possibility that management had found a better investment than their own shares would encourage me to retain my position. How likely was that? Well, we know that management believed in May that $760 million ($20 a share) was the minimum value of the company; Raina obviously thought the value was greater because he elected to be part of the GS buyout at $20 per share. This means that any acquisition would have to be able to be made at less than 55% of intrinsic value. In other words, the acquisition itself would have to offer a better than 90% return in the first couple of years to beat out a repurchase of shares. How likely is that? So my conclusion is that even if Raina proves to be a good operator, it is unlikely, under this scenario, that he is a good capital allocator. Given this, all indications point to Ebix being an investment I shouldn’t hold.
Note that I don’t say Ebix won’t go to $30 a share or higher, perhaps on a short squeeze or perhaps just because EPS leap forward. Nor do I think that you should necessarily come to the same conclusions as I have about holding the shares. My purpose in this post is simply to outline why I feel it is no longer prudent for me to hold the shares; I have simply lost faith in management.
Gravity Ltd. has had its difficulties over the past couple of years. I originally took a position in Gravity in 2010, built it over 2011 and sold out in February/March of 2012 when the ADSs hit a high of almost $3.50. Since then, the promise of Ragnarok II, which sent the shares to its 1Q 2012 high, has not played out. The relaunched game has only been moderately successful and no other games developed by the company have proved able to replace the original Ragnarok income stream. After the Ragnarok relaunch, the ADSs traded down significantly, falling some 50% from their high by year-end 2012 when it became clear that the Ragnarok sequel wouldn’t have the same success as the original game. When the ADS price dipped below the level of per-ADS balance sheet cash I repurchased one quarter of my original position. In hindsight I was not patient enough, and this entry point proved too high; ADSs have since traded down further as operations have continued to show mediocre results and more recently have become cash flow negative.
With ADSs down some 30% this year I decided to take another look. The company still has significant cash and short-term investments of about $46 million as of the end of Q3, or about $1.68 per share. At the current price of $.93 this means the ADSs are trading at a 45% discount to per-share cash! Wow! almost a $.50 dollar even if we consider that the other assets they own have no value whatsoever. To me, even with operations recently turning cash flow negative, there appears to be a decent margin of safety at this price. The question is can management turn the operations around? Or more precisely, is there a reason why management might be incented to turn operations around. Remember this is an entity controlled by a Japanese company, i.e. an environment where shareholder returns are not necessarily the primary interest of management. The recent downtrend in the ADS price may reflect a shareholder belief that operations will never turn around and the recent lows looks to me to reflect investor capitulation. This smells like a good opportunity! Perhaps December tax loss selling has provided a nice buying opportunity? Of course, management may simply continue its shareholder unfriendly ways and run the company into the ground. But with Gravity’s rather large cash buffer I think it prudent to wager that things may not be as bad as they appear. We’ll just have to have a bit of patience.
Long Term Value Blog 