About this time every year almost every investment blog tends to expound on how well their ‘picks’ did last year (assuming they did well), or how well their model portfolio performed against some appropriate benchmark. Sorry, readers, I’m not going that route. I will say that my own ‘value’ portfolio, mostly comprised of the stocks mentioned on this blog, was up about 20% last year, or slightly better than the S&P Total Return index, but I’m not proud of it; I should be doing better. So I’m going to dedicate my attention to what I’m doing wrong.
First, let’s review why I should be doing better than the indexes. I’m a relatively small private investor so I theoretically have a number of advantages over most of the professional portfolio managers out there. I have permanent capital, i.e. I don’t have to worry about maintaining liquidity for clients who want their money back at exactly the worst time. I can keep a large portion of my portfolio in cash without clients wondering why they are paying me to manage their money. I have a relatively small amount of assets under management and thus have minimal problems with entering and exiting a position, plus I have a larger potential universe of securities to invest in because I can create a meaningful position in all but the smallest microcaps. I have infinite flexibility to change my investment strategy on a dime, unconstrained by securities regulations or other concerns. And there are others. Of course there are also downsides to being a small private investor, such as higher transaction costs and limited research capabilities. All in all, however, I think the benefits far outweigh the downside. So I should, by all rights, be able to ‘beat the averages’ handily, however they be designated. The threshold is high, but it should be; after all its my own money I’m investing.
So with that perspective, my slight outperformance last year doesn’t seem so good does it? What’s wrong, then, with my selections or my methods? A quick look at my portfolio holdings brings an initial response. I’ve listed some of my advantages as a small private investor above. Those represent my edge over other portfolio managers. So am I making best use of my edge? Do all my positions reflect this edge? Unfortunately no. Look at my largest position, AIG; what’s my edge there? Yes, I know the company is still being shunned by many institutional investors because many of them were burned during the financial crisis of 2008 when the Treasury took a majority equity position during the bailout. Shares are still trading at less than 60% of book value, just the kind of investment I like. But I’ve got a lot of ‘company’ in the shares now. The Treasury sold its last equity interest in AIG last month (though they still own some warrants) so there are 1.5 billion shares in private hands. Hardly a narrowly held security. I don’t think my ‘size’ edge is very great here. The only thing I might be able to claim is I was in early (May 2011) when the stink factor was relatively high. But it seems to me that ‘stink factor’ is quickly wearing off and in the next six to twelve months it might be gone completely. I’m anticipating an exit sometime during that period, hopefully at 80% or 90% of book value. If the shares don’t respond as I’m predicting, I’ll be out anyway before my minimal edge completely disappears. My next largest position is Bank of America warrants. Bank of America is hardly a microcap. Yes, again I was in early (too early) when the stink factor was high, and at this juncture I have a positive return. But it has been a rollercoaster ride, and I can’t say that I took advantage of last year’s lows (12 months ago) when I should have. This was really an execution issue. This is a long term holding and I’d find it difficult to exit at this point. But I’m considering cutting back my position somewhat if the warrant price runs up substantially this year. So, in sum, my largest two positions don’t take advantage of my greatest edge, small size. My goal next year is to address this.
So my New Year’s resolution this year (like it was the last couple of years) is to be more disciplined. I want to define my ‘edge’ with each new investment. No,even more important, I want to justify each existing position with regards to my ‘edge’ and have the fortitude to make adjustments to my portfolio where appropriate. I’m going to be looking more at the microcap space and special situations.
Sorry, this post is rather tardy. I usually try to post about major portfolio changes within a couple of days, but about 10 days ago I took a substantial (for me) position in DGT Holding Corp. (DGTC). But really, this time I have an excuse! I’m late because I actually didn’t realize I’d taken the position until I returned from Christmas Holidays yesterday. Before I left on the 20th I put in a GTC order to purchase some DGTC shares, not really expecting the order to be filled. But much to my amazement, I somehow picked up a decent number of shares at $12.86! The investment thesis for DGTC is simple, and the company name should ring familiar to any regular reader of my posts (if not, see my writeups on SPLP). DGTC announced that it will, subject to shareholder approval, do a reverse split, a buyback of fractional shares then a forward split, effectively buying out all shareholders with less than 5,000 shares for a price of $13.50 per share. I hadn’t really been aware of the buyback until I saw this Seeking Alpha post which was referenced on my Yahoo finance portfolio page (under SPLP). Of course, by the time I read the Seeking Alpha post the DGTC share price had already moved up to the high $12 range. But I had some cash just sitting there earning practically no interest and I thought, well, why not, if I can make maybe 5% for tieing up this cash for a couple of months it might be worth it. Even if the buyback doesn’t go through (and I’m not sure why it wouldn’t, given that SPLP controls over 50% of DGTC) there is an ample margin of safety here; DGTC has over $14 of cash per share outstanding. Note that the buyback will be accretive to DGTC book value (and thus to SPLP book value because DGTC is consolidated on SPLP’s books).
The market price of DGTC has continued to creep up toward the buyout level so the opportunity to get a 5% return is no longer available. But, who knows, there is plenty of time for the spread to widen again. I assume the shareholder vote will take 30 to 60 days during which anything might happen.
This is an interesting little arbitrage, but, more importantly, it is another step in unlocking the hidden value in SPLP.
Note: I’m not going to update my Portfolio page for my DGTC purchase because I expect it to be a short-term investment of only a month or two, with the final buyout price already known.
I just completed my year-end cleaning of the stables. Goodbye Aberdeen International (AABVF)! I’ll be the first to admit my mistake on this one; I was wrong to buy into Aberdeen in the first place and even ‘wronger’ to hold on as long as I did. This was a clear case of bad due diligence and bad psychology. With Aberdeen I focused solely on discount to NAV. But it turned out that NAV that was sinking sharply even while I was doing the calculations. I wanted to have some leveraged exposure to gold due to my long-term macro view on the economy and inflation and thought the ‘junior’ status of the mining shares in this closed end fund would provide that leverage, with the discount to NAV also giving me some margin of safety. Somehow I overlooked the ‘quality of management’ issue and instead listened to the siren song of what management was promising, a strategy to reduce the discount. As it turned out, not only did I get the timing for junior gold miners wrong (something I should always take for given), but I also pathetically succumbed to the ‘promises of management’. These are classic mistakes of a neophyte investor and I am chagrined and appropriately humbled. What more can I say? The only saving grace was that this was little more than a tracking position in my portfolio. Phew!
My ‘macro’ vision, as myopic or stigmatic as it is, still makes gold a desirable holding for my portfolio. Over the coming decade I think we stand a good chance of seeing significant inflation, during which, hard assets will be rewarded. So rather than take the dollars invested in Aberdeen off the table I have simply rolled them over into additional shares of NovaGold, where I have a bit more than a tracking position. This latter was my primary ‘leveraged’ speculation in gold. Leveraged because the company is just in the permitting stage and will take another 4 years to bring the Donlin mine to production. As I think I have mentioned, I like NovaGold because it holds a 50% interest in the Donlin tract and has no current production. The balance of the Donlin rights are held by Barrick Gold, which can be thought of as the successful operating partner and potential buyer of NovaGold’s interest IF gold prices rise and the mine pans out (excuse the pun).
I think that’s it for housekeeping until the new year. Happy Holidays everyone…may we all have a healthy and profitable New Year.
Here’s a company that has been growing revenue at about 30% for the past 3 years and has translated about 40% of revenue into operating cash flow each year. What’s not to love if the company’s stock is trading at about 9 times earnings? Well, someone out there, and probably several someones, have got it in their head that what looks too good to be true really IS too good to be true; there’s a short thesis that says EBIX’s revenue growth is being achieved through financial shenanigans, or, at best, through its strategy of serial acquisition. To put it simply, EBIX’s base business is not really growing at all; growth is coming solely from acquisitions, and revenues will level off the moment the acquisition strategy is played out.
I guess the fact that I bought shares in EBIX well after the short thesis was put into the public domain should tell you what I think of the short thesis. Don’t get me wrong. I value the role short sellers play in the stock market. But just as there are long theses that are wrong, so too are there short theses. The biggest problem I have with the short thesis on EBIX is not the thesis itself, that will prove itself out in the long run, or not as the case may be, but the tactics that have been employed by the shorts. To my mind its alright to come out and give your short thesis about a company’s stock in as public a forum as you can find. No, not just alright, I think it should be commended. Investors can get far too optimistic about things. Shorts are important in damping mass hysteria (though one might ask where they all were when we needed them in 1999?), and they are even more important in ferreting out financial shenanigans a la Enron. I’m all for shorts and the role they play. However, I really think it hurts one’s credibility when one has to resort to ‘anonymous’ negative statements about a company. Just look at the recent episode related to EBIX; in early November Bloomberg published an article titled “Ebix Accounting Practices Said to Be Probed by SEC” which stated that EBIX “is being investigated by the U.S. Securities and Exchange Commission for its accounting practices, four people with direct knowledge of the probe said.” Pretty mysterious, no? It sounds like a scoop! But wait a minute, who were the four people (and why four, wouldn’t one or two have been enough)? Were they from the SEC or EBIX? If they were, aren’t they prohibited from talking about an investigation until it is made public? If not, how could they have ‘direct knowledge’ that an investigation was underway? I don’t think we’ll ever know the answer to these and other related questions.
Though EBIX and CEO Raina did whatever they could to dispel the ‘rumor’ (a public statement that they were unaware of any investigation), the stigma seems to have lingered and shares are down some 30% since. There is, of course and not to be discounted, the matter of compressed margins in the 3rd quarter which, I’m sure, hasn’t helped the share price either.
But let’s get to the matter at hand. EBIX is not my usual kind of investment. It has a low tangible book value relative to market cap, meaning the balance sheet has a lot of goodwill/intangibles. I’m usually an asset guy, with earnings secondary. But I AM a ‘glitch’ guy! I first bought in last March (the first ‘glitch’) when there were earlier rumors about fraud swirling around the company. Now I’m upping my stake with the new rumors. If I’m right (and there’s no guarantee of that, let me assure you) this is an opportunity to invest in a true growth business at a reasonable price.
How do we know the shorts aren’t right? The short answer (!) is, we don’t. Theoretically one might look at the original businesses and the acquisitions separately. Are the original businesses producing organic growth? or is all revenue, income and cash flow growth coming from acquisitions? In reality, of course, we can’t do those calculations as management doesn’t provide this kind of granular information. So instead, lets look at things a little differently. Let’s take more of a global view. We can see that operating cash flow over the past three years is substantially the same as operating cash flow. That’s a pretty good start; cash in the bank is hard to falsify, unless, perhaps, you’re in China. How much cash has been generated and how has it been used? About $172 million in operating cash flow has been generated since year-end 2009. About $6 of that has been returned to shareholders through dividends (which began this year). The balance was used to make acquisitions and repurchase shares. We’ll also have to consider that debt has increased from about $52 million to $80 million over this time, adding another approx. $30 million in cash which was used. I’m not counting share repurchases as cash returned to shareholders as, you will note, the share count, despite the substantial repurchases, is up slightly. Initially I worried that share repurchases were just keeping pace with the exercising of options, i.e. they were nothing more than disguised management compensation. But this doesn’t look to be the case; I see that there were some convertible notes that were converted during the period in question so the share repurchases were, in effect, just a form of paying down debt. Whether issuing the converts was a good strategy in retrospect is something to go into on your own; we’re concerned here with ‘the big picture’.
So lets say EBIX spent about $195 million (plus the future earn-out liabilities) to get what? Well, let’s make another gross assumption and say that the business that EBIX had at the end of 2009 remained flat (the shorts might think I’m being generous). Thus all incremental Revenue, Net Income and Operating Cash Flows we can attribute to the acquired businesses. I’ve taken the run rate of the 3rd quarter 2012 and subtracted the average run rate of 2009 to get some incremental numbers. By this measure EBIX has added revenue of about $30 million, net income of $9 million and operating cash flow of $10 million per quarter. On a cash basis, which is what I’m mostly concerned with, this means we’re getting $40 million in run rate OCF for our $195 million investment. Since I see that EBIX has relatively small Capex requirements (less than $2 million annually, including the acquisitions) we’ll just leave that out of our equation for the moment. So assuming the acquisitions are self-sustaining and have NO GROWTH, we have gotten a return on our $195 million investment of around 20%, leaving aside the earn-out liabilities (which we can’t evaluate due to lack of information). Now if, instead, we assume that EBIX’s base business actually had some organic growth over these three years, our imputed ‘return’ would be lower. But then again, we might also expect the acquired businesses to have some organic growth, don’t you think? (otherwise why did EBIX buy them?) And the impact of these two might cancel themselves out. So, using our back of the envelope approach, it looks to me like we believe 1) the original EBIX businesses were mediocre at best but management is great at acquiring companies with accretive earnings, 2) growth at the original EBIX businesses has been going gangbusters and management is poor at buying and integrating accretive businesses, or 3) somewhere in between; the EBIX base businesses have been growing at least modestly and management has boosted growth with a successful accretive acquisition strategy. I think you know where I come out on this one.
This over-the-top analysis is no proof that the shorts have it wrong, but it illustrates the way I think about the investment. It is just a kick-off point for any potential investor to see whether further in-depth analysis of EBIX is warranted.
I know. I know. I said I was contemplating doubling down on Myrexis at $2.75 a share just a month ago, and here I go selling out! Well, the shares drifted up to $2.79 and the company revised the initial payout range downward in the preliminary proxy statement. Paying $.03 per share for a chance for up to $.19 in an initial liquidation payment, as laid out in the original press release announcing the liquidation, plus a share of something left over in three years, seemed like an interesting proposition. But paying $0.12 per share for up to $0.17 of upfront liquidation payment plus a share in what’s left over, is another matter, especially because the preliminary proxy gives no hint of what the ‘something left over’ might actually be worth. The other consideration is that I can take the capital loss this year and potentially get back into the deal if the share price trends down or more information is provided in the definitive proxy. I must admit that a good part of the impetus to sell was due to the fact that I couldn’t quite figure out if I would have to wait the full three years until the final liquidation payment to take the capital loss (a bit lazy on my part).
In any case, the position is now sold, though I will continue to monitor the MYRX share price to see if a suitable opportunity arises to reenter the position with a new investment thesis.
Gravity’s 3rd quarter results were disappointing, a loss of $.05 per share, on decreasing revenues, both sequential and YOY. Second quarter results had pointed to continuing losses, with sequentially decreasing revenues and increased advertising and sales expenses related to the lauch of Ragnarok II. I should have foreseen that this would probably continue for several quarters at least, but I think I was just blinded by the results of my first investment in the ADRs. I always have to remind myself that you see what you want to see; Kahneman! After all, my first forray into GRVY produced a better than 100% return; I loaded up about this time last year, after taking a small initial investment two and a half years ago, and cashed out last March when the ADR price spiked on news of the lauch of Ragnarok II. I’ll take credit for the loading up around $1.20 but I’ve got to admit that selling last March at the high was SHEER LUCK. I had no idea that the ADRs would fall so far so fast. Little did I know that 1) acceptance of the new game would be slow (if it happens at all) and 2) that there would be enough additional sales expense to produce operating losses, at least until additional revenues kick in (hopefully). In fact, I began a new position last Summer at the $1.70 level, thinking that getting back in at the net-net level was bound to be safe once the new game was launched and game development expenses were finished. But now, here we are again, back at the $1.20 level. Is it time to ‘back up the truck’? How do I know? Mr. Market is a queer fellow! The ADRs could drop substantially from here, especially if operating losses continue or increase. The one thing I DO know is that the company still has $1.83 in cash per ADR (down from $1.89 at YE 2011), though some of that is at the subsidiary level and is not directly available to shareholders. This means that at the current ADR price, for each $.55 you invest, you’re getting a dollar (or equivalent Won, in this case) in cash plus the operating business thrown in for free! Is the operating business really worth $-.63 per ADR? Even if the company loses $.05 per quarter for the next few quarters I don’t think so.
Am I ‘backing up the truck’ at this point? Well, not quite yet. After all, we are at the beginning of tax selling season and I wouldn’t be surprised to see Mr. Market dump a bunch of ADRs on the market over the next month. At the beginning of 2012 the ADRs were trading at $1.45, so anyone who took a position this year is sitting on a loss. Even better, the ADRs subsequently rocketed up to $3.40 in March, meaning that anyone buying in the euphoria rally might just be thinking about dumping their position about now for a nice hefty tax loss. So I’ll just be waiting around with the dump truck to see just how low these ADRs can go.
But to answer Sid’s implied question, did the poor 3rd quarter results shake my investment thesis, NO, the cash is still there, as is the promise of a potentially successful game. Of course, I’m willing to sit on a position in GRVY for YEARS, waiting for Mr. Market to have another manic moment. You should, as always, do your own due diligence and, if you do jump in, be willing to see your investment cut in half (like I’ve experienced with Fortress Paper). So, before you act, ask yourself whether you would have the Chutzpah to invest the same amount again if the ADR price was subsequently cut in half. If not, this kind of investing is not for you!
If this isn’t an opaque security! And you know what? That’s just what I like! Very little information trickles out of the Lichtenstein machine, just the essentials, or maybe just the required.
Management continues to make slow but steady progress towards simplifying the partnership structure, merging entities under partial control or selling off investments that are non-core. Remember that the partnership is basically an investment partnership, not an operating partnership. As such, it holds investments in a number of public and private companies. But because some investments are controlling investments, i.e. greater than 50% ownership, it consolidates these from an accounting perspective, while the rest are accounted for using either the fair market value or the equity method. This makes the financials a giant hodge-podge and relatively useless in valuing the partnership units, especially over time since changing ownership interests lead to changes in accounting treatment (from equity investment to consolidated, for example). To get a cleaner picture of the partnership value one needs to tote up the value of the various holdings. For interests in public companies this is relatively straight forward. It is the interests in private companies that make valuation more problematic.
Before I lay out my valuation let’s go over some of the major events at the partnership this year. [For a history of this strange entity please read my earlier two posts on SPLP, here and here.] SPLP was finally listed on the NYSE in early April providing improved liquidity to unitholders. Then, at the end of April, BNS was folded into Steel Excel through a transaction that cashed out minority shareholders and exchanged Steel Excel shares for those BNS shares held by SPLP. This resulted in SPLP’s interest in Steel Excel increasing to over 50% which meant a change in accounting treatment; with a majority interest in Steel Excel, SPLP now needed to consolidate Steel Excel financial results into its P&L. In August, SPLP increased its ownership DGT Corp. from 51% to 57%. Then in early October the company sold its interest in Barbican for £21 million (approx. $33.8 million), about twice the value, I believe, at which it was carried it on the books.
All of these events reflect slow and steady progress toward simplifying the partnership structure, and, I believe, making the value of the underlieing assets more visible. I have taken a stab below at an estimate of net asset value for SPLP as of 9/30/12 , though I have taken the liberty of reflecting the subsequent sale of Barbican equity.
$ in millions (except per share amounts)
| Company | Ownership |
Accounting |
Holding |
| Publicly traded | |||
| Steel Excel | 51% | Consolidated |
$167 |
| Handy & Harman | 54% | Consolidated |
$107 |
| Gencorp | 7% | Fair value |
$39 |
| DGT Corp. | 58% | Consolidated |
$29 |
| JPS Industries | 41% | Fair value |
$28 |
| API | Fair value |
$23 |
|
| SL Industries | 24% | Equity method |
$15 |
| Nathan’s Famous | 10% | Fair value |
$15 |
| Cosine Comm. | 47% | Equity method |
$9 |
| Subtotal |
$432 |
||
| Private/Other | |||
| Fox & Hound | 44% | Equity method |
$30 |
| WebBank | 100% | Consolidated |
$22 |
| Liq. Trusts |
$15 |
||
| Other |
$21 |
||
| Subtotal |
$88 |
||
| Cash |
$72 |
||
| Total NAV |
$592 |
||
| NAV per share |
$18.40 |
Based on this anything-but-exhaustive analysis, the units (at around $12.00 today) are trading at about a 35% discount to NAV. To get a better picture of the real discount one has to consider not the market price of the underlying securities owned, but the actual value, perhaps even the private market value. For example, there was a recent write-up on DGTC at the VIC website, that concluded the value of DGTC was somewhat north of $19 per share rather than the $12.50 it is currently trading at.
I have a full position in SPLP now but would consider increasing it if year-end selling were to depress the unit price to the $11 or under territory.
This was one of my early investments and to date one of the more disappointing. When I initially invested (post-spinoff from Myriad Genetics) MYRX shares were trading at about $4.00, only about 57% of the $7.00 cash per share on the balance sheet. This looked like an ample margin of safety at the time, but I was pretty much of a greenhorn when it came to investing in biotech stocks. That was mid 2009, and, in retrospect, clearly I was wrong both about the margin of safety and about management’s intentions and/or capability. Live and learn!
Last week the company issued a press release announcing Board approval of a liquidation plan. The release disclosed that the plan calls for the company to distribute all available cash (between $2.72 and $2.91 per share) as soon as shareholder approval is obtained. On reflection I realized that this means the company burned through around half of its cash and investment hoard in 3 years! What did we shareholders get for that ‘investment’? The press release made no mention of any assets (intellectual or otherwise) to be disposed of by the company after the initial cash distribution, though I expect further information will be forthcoming in the shareholder proxy material.
I am contemplating doubling down on my investment at $2.75 a share or below. With some cash floating around from my sale of BBEP units and interest on idle funds providing practically no returns, this kind of short-term, non-market-correlated investment seems appropriate. The investment proposition is this: at worst I would receive $2.72 in the initial distribution which should take place some time early in the first quarter of 2013, and at best, the initial distribution will be at the high-end, $2.91, providing a return of 5.8% in say three months. That means I would be investing at most $.03 per share for the possibility of further upside if some of the withheld cash ($12 million in the low distribution scenario) is left over at the end of the liquidation process and/or a buyer can be found for some of the intellectual property developed with shareholder’ $100 million investment. That seems like a pretty good proposition to me since projections made under a liquidation scenario are generally very conservative.
This is not a happy ending for my MYRX investment. I’m down 36% on my initial investment with little prospect of substantially improving the return; I’ll be lucky to end with a 30% loss on the position if I end up ‘doubling down’ even under the most sanguine of scenarios, but I will have learned something. To invest in a net-net in the biotech area you have to be sure of management’s track record and incentives. During the development of my investment thesis I should have given more weight to management’s background and precluded the investment because top managers had NOT previously been involved in a SUCCESSFUL small, stand-alone biotech startup. Furthermore, the mangement incentive structure was not right; management had options but didn’t own enough of the company (skin in the game). And finally I should have acted immediately and sold my position when MYRX bid for Javelin in the Spring of 2010 as management made little attempt to explain and justify this incomprehensible move, a further indication that management’s interests were simply not aligned with those of shareholders.
I’m generally not a macro investor, basically because I don’t think it’s possible to forecast where the economy or the stock market is going. But, right now I’m a bit worried. The S&P is up over 15% this year and the economic situation does not look better now than it did in January. There are a number of economic hurdles coming up shortly, the presidential election and the fiscal cliff, just to name two of the the most obvious. US politicians seem to be ignoring the HUGE government budget deficit and national debt (on both sides of the aisle they spout rhetoric but no one seems able to find a compromise – and isn’t that what leadership is really about?) All politicians seem hell-bent on kicking the can down the road rather than tackling it head on. Nothing good can come of this. I have to agree with Wexboy in his no-holds barred analysis of the current situation and the inevitability of INFLATION. So where to invest? The same places we always do, special situations, spin-offs, recaps etc. But these seem to be few and far between these days. In fact, my rate of posting is down over the summer exactly because I don’t seem to be finding ANY compelling special situation opportunities outside of the ones already in my portfolio. Usually, just about the time I begin thinking that I should lighten up on equity exposure (like now) because I can’t find any slam-dunk opportunities, Mr. Market takes a substantial drop and I’m left with little cash to take advantage of the lower prices. This time I’m moving sooner (and likely Mr. Market will instead MOVE UP this time). But it’s the comfort factor I’m after. I’m trying to build a 25% cash position. So I’ve begun selling off some positions that have either run up considerably or have added risk since I first entered them.
I’ve completely sold out of my position of Howard Hughes Corp. (HHC). I still think there is great upside in the share price but this is a company with assets that are going to take years to develop and bring to fruition. I’m in LTCG territory on all my shares and with the uncertainty of next year’s treatment of capital gains I thought it prudent to take the gain now. The position is up over 55% in the 2 years since I began accumulating it.
I’ve also sold out my position in Gramercy Capital (GKK). My investment thesis was based on restructuring or selling the company not rebuilding it. With the hiring of a new CEO 3 months ago, the Board has set a different direction (raising capital and remaining independent) from that which I had hoped. Even though the new CEO put up over $2.5 million of his own money to purchase shares (and thus filled in what I considered a weak point of my investment thesis – low or no insider ownership) I think this work-out is going to take much longer than I originally anticipated. I still think there is still considerable potential upside in the shares and I would consider repurchasing my position in the low $2 per share range.
Cash now at 12%… and counting. What’s next?
Didn’t I write the same post 6 months ago? Yep, in February Breitburn raised $173 million (9.2 million units priced at $18.80) and now they’re at it again. This time 10 million units at $18.51 to raise $178 million (or up to $204 million if the underwriters take up their optional overallotment). Once again dilution for unitholders, with book value falling yet further. But are we unitholders being unduly penalized by management’s acquisitive nature?
I took a look at distributions. Since being reinstituted in March 2010 distributions have risen at a 9.5% annual rate. That’s not bad but you have to consider that when distributions were suspended in early 2009, the annual rate was $2.08 or about 12% above the current level. Furthermore, book value has declined about 10% since early 2009. This is not very encouraging but still, with units yielding about 10% and the distribution growing about 9.5% annually, Mr. Market still seems to be penalizing us unitholders, perhaps because of management’s poor showing in 2008/2009. Maybe the haircut is warranted, but if distributions can continue to be raised at the current rate, and that’s a big if, the units appear to me to be underpriced. What would you pay for a security paying out $1.84 annually, yielding 10% with the payout growing 9.5% annually? That’s certainly more attractive than a fixed income security paying 10%. And did I mention the payout is linked to the price of oil?
Recently, I was considering liquidating my position in Breitburn even though the unit price hasn’t reached my target of $24 (the book value when I purchased). Raising cash, looking out to potentially higher tax rates next year and all that seemed good reasons. After all, the unit price has more than doubled since I purchased the position in 2008/9. But, on reflection, I think I’ll wait to see what the growth in the distribution is over the next two quarters. If management can continue growing the distribution at a 9-10% annual rate, it seems to me, given the low-interest environment stretching before us, that the units should yield more in the range of 6-8% which translates into a price 25-40% above today’s level.
Is there a potential downside? Of course! With all the asset purchases over the past year the company may be growing too fast and the anticipated cash flows from the new properties may not be sufficient to continue growing the distributions given the increase in the number of units outstanding. A slowdown in the growth of the payout not due to fluctuations in the price of oil seems to me an appropriate trigger for reconsidering a sale in six month’s time.
Long Term Value Blog 