See below for notes forwarded to me from a friend. If anyone else has Ira Sohn Conference notes and would like me to throw up on the blog, let me know.
This is a summary of ideas expressed at the Ira W. Sohn Investment Research Conference today, Wednesday, May 27, 2009. The Ira Sohn Research Conference Foundation is dedicated to the treatment and cure of pediatric cancer and other childhood diseases.
NOTE: The notes below were taken in real time, but we apologize in advance for any transcription errors. THESE ARE THE OPINIONS OF THE SPEAKERS, BTIG DOES NOT AGREE OR DISAGREE WITH ANY OF THE STATEMENTS.
Peter Thiel, Clarium Capital
Thiel is taking a long term time horizon and contrarian perspective as to whether this is a financial crisis at all. He asserted that productivity growth is the key to increasing the standard of living. Thiel explained that there are 3 ways to create productivity: Additional Leverage, Globilization and Science & Technology. We are witnessing the results of the Additional Leverage. Thiel believes the virtuous effects of Globalization are behind us. Instead of the disinflationary influence it has had over the past two to three decades, inflationary forces will take hold as nations compete for resources. In the area of Science and Technology, Thiel believes that things are not healthy in the ever expanding universe of human knowledge. Major research is turning out to be fraud and there is actually less progress than there appears to be in science. Technology, the application of science and also has not made much progress. Examples include the venture capital community, which has not made money in 10 years, there is no money being made in IPOs and the poor conditions of the State of California.
Thiel believes this is not a new problem and this has been going on for a very long time. 1969 may be the year that progress died. Innovation has been barely enough to keep up with global constraints. Thiel referred to the Tech boom of the late 1990s as a fraud. He questioned how you get high returns in a world with such little innovation. You get the high returns through high leverage. High leverage is a symptom and cause of failed innovation of the past 40 years.
Thiel believes there will be no V shaped recovery until the productivity issue fixed. He also noted that he believes the U.S. Government is nowhere near being on the right track. And he would fade the recovery trade, we will see inflation in assets we need (commodities) and deflation in assets we own. He believes the U.S. is radically misdiagnosing the problem. Washington is dominated by lawyers and economists and not the scientists that are necessary to correct the problem. Thiel referred to the situation as the myth of technological progress and asserted that most innovation we have received is hype. He discussed large cap tech names in a pejorative manor stating that betting on established Technology companies like Cisco, Microsoft and Intel is a bet on no innovation. He thinks we should be looking for companies that are truly innovating, of which there are only a handful.
Joseph Healey, HealthCor
Healey outlined the great demographics behind the Health Care industry while analogizing the current Health Care reform movement to the Hillary Care movement of the early 1990’s. Healey noted that Health Care is projected to become 20% of GDP by 2018. Advances in Health Care have increased life expectancy from 47 years in 1900 to 78 years today. Uncertainty about the Administration’s push for Health Care reform is creating an overhang in the group, similar to Hillary Care overhang in the early 1990’s. From the time Clinton took office to the time Hillary Care was quashed in 1994, Health Care underperformed the market and when Hillary Care was quashed, Health Care drastically outperformed. Once reform begins to take shape and there is clarity to the situation the stocks will improve. He believes the overhang created by this uncertainty creates a good investment opportunity.
Healey discussed 3 companies that he believes have significant upside potential. First, he discussed Valeant Pharmaceuticals (VRX). The cornerstone for Healey’s thesis was the potential for its epilepsy drug, retigabine. Glaxo has partnered with Valeant on the drug. Wall Street has significantly underestimated the upside potential for the drug. Healey noted it is his belief that if Glaxo does not acquire or take over the company, then the stock has potential to rise to the $40 to $50 range. The second stock Healey discussed was Hologix (HOLX), which he believes has potential to double from current levels. He described it as one of the most compelling new product stories in the MedTech group. The business is 70% consumables with a razor-razor blade model and has a Free Cash Flow yield of 10%. Healey’s final idea was Life Technologies (LIFE), where he noted the 8% Free Cash flow yield and upside potential of 60% from current levels.
Mark Kingdon, Kingdon Capital Management
Mark Kingdon opened up with a slide on Bank of America titled “An extraordinary opportunity?” Kingdon noted that Bank of America (BAC) is trading 5x normalized earnings. He discussed the severity of the Government’s SCAP (Stress Test), which he noted was rigorous. Kingdon noted his firm’s analysis arrives at a Tangible Book Value of $11 per share for BofA. Kingdon noted the franchise businesses of BofA and its position as the largest Commercial and Retail bank. Kingdon arrives at Normalized Earnings per share is $2.24 using inputs of 1.2% for the loan loss provision and net interest margin of 2.75%. The loan loss provision is quite high based upon net charge offs over the past 20 years, with the exception of a short period of time around the S&L crisis and the current environment. Kingdon believes the net interest margin of 2.75% is conservative and should expand since the Fed has created a steep yield curve and there is less completion in banking industry. His firm’s analysis leads Kingdon to believe that BofA has potential to rise above $20 in a year.
Steve Mandel, Lone Pine Capital
Mandel started by noting the two components he looks for when seeking a margin of safety: price paid and strength of business franchise. If given a choice of one or the other, Mandel’s preference is strength of the business. In the current market, great franchises have been stagnating while cyclical rally is occurring. Mandel believes that Strayer Education (STRA) is one of those companies with a superior franchise. There is a huge, underserved demand for working adult secondary education and traditional universities not set up to serve these customers. Strayer’s graduation rate is above community colleges and its student loan default rate is low. The Company has partnerships with corporations to educate employees. Strayer’s operating margins are in the mid-30% range. The company needs little capital to operate and grow its business. In 2008, only 20% of $100 million in cash flow was necessary to grow business and the balance was returned to shareholders through various means. Mandel believes sales and profits should grow 8x over the next 10 years. Currently, the company is trading 25x this year’s earnings and 20x next year’s earnings. Those multiples should contract quickly as the company grows. The $2.5 billion market should be much larger by the time STRA is a fully national company.
Jim Chanos, Kynikos Associates
Chanos’ presentation was titled “For profit social services from the trough to the slaughter house.” Following the 30 year deregulation boom in Health Care, Education, Financial Services, Defense and Government Services, the Government will be looking for payback. Health Care faces significant reform. Education is becoming a right and not a privilege and that will cut into margins. Investors find themselves questioning the very foundations of society. The Administration believes Health Care and Education are civil rights and part of its legacy. Chanos refers to the groups at risk of seeing their profit margins cut by Government reform as Capital Offenders.
Chanos highlighted For Profit Education where federal funding represents 73% of revenues at the top 4 companies. The margins for the group are 27% much higher than the 12.5% of the S&P 500. Instructional costs as % of revenues declining, not reinvesting in educating the students. Government funding has fueled double digit student growth. Students at these proprietary schools are saddled with more than 58% than students at traditional school. The companies valuations leave no margin for error.
Chanos also highlighted the challenges to Health Care. Margins in the group are approximately 50% greater than that of the S&P 500. Big pharma spends 3x more on advertising than they do on R&D.
Currently Health Care represents 16%-17% of GDP that is 2x that of the rest of world with worse outcomes. There are 45 million Americans without health insurance the administration’s attempts to insure these individuals will cut into margins. Health Care gross margins range from 30%-70% and operating margins are 50% better than the S&P 500. Government will look to take these actions to contract margins. Chanos is shorting Lincare (LNCR) where margins are still among the highest in the industry. He believes it will be poster child for what is about to happen to the Health Care industry.
Peter Schiff, Euro Pacific Capital
The U.S. Government is interfering with the free market forces trying to fix the economy. We lived in a phony “bubble” economy. The Government is trying to reflate the bubble. Americans are trying to rebuild their balance sheets and save to build wealth. As any drug addict knows if you stop using drugs you will go through withdrawal. Government is making the situation worse. We don’t need any more stimulus, we are suffering from the stimulus we have already been given. Alan Greenspan and Federal Reserve got everyone drunk on easy credit. Government has created moral hazard, i.e. Fannie and Freddie. The housing bubble was Fed and nurtured by the government. America is broke and our creditors are acknowledging that.
What is going on in the global economy will not last and is beneficial to the rest of the world. Foreign nations will retool factories and create products for themselves. Our ride on the global gravy train has come to the end. The whole service sector economy has to go away. If companies are not profitable they need to go out of business. Nobody talks about the productive jobs the Government destroys by saving jobs at GM or AIG. The damage this time around can be far greater than Hoover and Roosevelt created during the Depression. Hoover attempted to bail out the economy and business, Roosevelt only followed his failed policies on a much larger scale. Bush has followed bailout policies like Hoover, now Obama’s is following Bush’s failed policies only on a much larger scale.
Japan was in a good position when they busted, we are in the opposite position. We can’t solve a crisis that is the made of borrowing and spending by more borrowing and spending. Our creditors will stop lending to us. Inflation is going to run out of control. Ultimately that inflation is going to cause prices to go through the roof. We will not be able to purchase items to go on store shelves. This not a major collapse, it is a restructuring. The decoupling concept is here, but the US is not the engine it is the caboose.
You need to own assets in countries where economies will thrive and prosper like Asia, and stay away from US assets. This is the beginning of an inflationary depression.
Lee Hobson, Highside Capital Management
Lee Hobson of Highside Capital presented two straight forward investment ideas, one long and one short. Hobson cited the opportunity in emerging markets where low (wireless) telecom penetration = high growth potential. Hobson noted countries who introduced wireless technology later have faster growth curves and adoption rates thanks to cheaper technology. Hobson like Millicom International (MICC) to play this trend. Cellular service in emerging markets proven trend that offers affordability and high utility to the consumer. He equates it Coca cola 50 years ago. Building a strong internationally recognized brand among consumers who crave the product. MICC sells their service internationally under the Tigo brand. The product is accessible, affordable , available (strong networks) and serves the consumers need to communicate. Millicom has a 25 year emerging market history. They serve growing less developed countries with a total of 290 million people. Wireless penetration ranges from 10% to 80% in their markets –in developed markets penetration is above 100% (multiple phones). The company trades 3.6x forward EBITDA and is growing cash flows at 20%. The companies growth can be self funded an it can grow secularly for a long time with consistency.
Hobson suggested betting against auctioneer Ritchie Bros. The company is an auctioneer of used industrial equipment. It earns a 10% commission rate on what the auction price. To grow earnings they need to grow revenues. The company is trading 29x earnings and 16x EBITDA. Earnings growth accelerated over the past 5yrs transitioning from single digits before to high teens. Company has a 15% market share and company claims it will grow through market share gains.
Hobson states the real growth driver for the company has been equipment price inflation (as a result of the building boom). The company also did a significant amount of capital intensive site builds, but their “same store sales” only grew at a rate of 2%. The volume trends of the business are not likely to be countercyclical as the company suggests. Company had to spend 90% of cash flow to grow revenues but in both the slow and fast growth environments their capacity increase CAGR was 6%. Commercial Construction lags the economy, non residential orders and are backlog collapsing. Management is selling stock and made sales as recently as last week. EPS likely peaked in 2008
Paul Singer, Elliott Associates
Investor have become accustomed to the post war solid growth model. It is likely the solid growth, stable inflation model is gone. There will be a period of deleveraging in an environment of high inflation with areas of deflation. Certain elements of current environment concern Singer. Singer discussed regulation and fears this era of anti capitalistic behavior. He expects a global scheme on the limitations of leverage. Hedge funds did not blow up the world, regulated entities did. Singer is concerned about the treatment of investors in the secondary market for debt. He fears restrictions on the ability for investors to exercise their rights will prevent the flow of capital to markets.
Singer discussed the rule of law. He noted it is devilishly hard to preserve private capital for a long time. Rule of law is a necessary but not sufficient condition. The color of money can change over time. Capital will flow to where it is treated best. Arbitrary actions that circumvent the law for the purpose of achieving a short term government objective will have long term consequences. Rule of law needs to win over the rule of enlightened elite. The government is elephant in the room- hope it the government cares what the room looks like after it is done stomping around the room. It is important to get through this challenging time with our time tested principles intact.
Bill Ackman, Pershing Square Capital Management
Bill Ackman laid out an in depth case as to why the equity shares of General Growth Properties (GGWPQ) are a good investment despite being in bankruptcy. It all breaks down to the company’s assets are greater than their liabilities. Through several potential workout agreements or a court appointed “cram down” the equity should greatly benefit from the likely scenarios. As far as a business General Growth’s malls have over the country 24,000 tenants. The company has 73 “Class A” malls, and high profile names like Faneuil Hall and South Street Seaport do not even garner that high rating. At General Growth 50 of the 200 malls create 50% NOI. Malls historically generate high stable cash flows. General Growth has fixed rates on 83% of debt. This is a business where inflation is an asset. In losing Circuit City the company lost a tenant paying below market rents. The company’s problems result of the CMBS market collapsing. The credit market shutdown prevented them from rolling their debt. They have the second highest occupancy of any mall company. The NOI is actually from the levels where the company’s market capitalization peaked.
Ackman made the analogy between General Growth and the situations that occurred at Alexanders and Amerco (U-Haul). These were bankruptcies where assets are greater than liabilities. During bankruptcy a creditor entitled to their claim but no more, and in this case the equity will be left with value. Ackman suggests two potential options- either an extension of current debt 7 years or a debt for equity swap. He notes either scenario would create approximately a per share value emerging from bankruptcy $20 go to $35. Another option would be if the bankruptcy court forced a “cram down.” In this event Ackman exhibited precedents where the company’s interest rates would be lowered creating a better scenario for the company. Ackman notes the likelihood of forced liquidation by the court is minimized because of the extreme pressure it will place on the commercial real estate market and other REIT’s.
David Sokol, MidAmerican Holdings Company (Berkshire Hathaway)
Sokol is not seeing the green sprouts -- but that is not surprising to them. Government intervention can draw this out longer than necessary, but is useful in some circumstances. Unemployment will rise north of 10%. They are not seeing much improvement in housing. 92% of loans they have seen this year are all conforming. Although there are in excess of 1 million household formations per year, Sokol believes the backlog of 10-12 months is actually 2x that amount of yet-to-be-foreclosed homes. Sokol expects it to be mid-2011 before a balanced home sales environment emerges (6 months of inventory).
In regulated energy the headwinds are greater than any time in his 30-year experience. Inflation and rising borrowing costs are challenging headwinds. The utility industry can handle carbon emissions restrictions, but the cap & trade legislation as currently written will drive up energy prices for consumers to levels that will be hard to digest.
David Einhorn, Greenlight Capital
The theme of David Einhorn’s presentation was the curse of the AAA. Obama administration is following the same policies of the Bush Administration. The administration is reflating the economy back to 2006 levels. For the economy to recover underwater entities need to restructure their debt. The willingness for banks to negotiate in this environment depends upon where the positions are marked. The Obama loan modifications lack the most important aspect of restructuring –debt reduction. The debate in the banks was too narrow with only two options discussed - Nationalizing versus Taxpayer Bailout. There is a 3rd option, debt or preferred equity conversion to common equity. Attempt to induce debt of equity conversions without creating a downdraft in the group. Banks are not materially more solvent today than they were two months ago. Regulatory forbearance has created this rally in banks. We should be overcapitalizing the banks and direct them to restructure the debt of their borrowers. The Government spending and guarantees put the U.S. AAA credit rating at risk. US debt need s to be managed responsibly.
Einhorn took to task Chairman Bernanke’s assertion that AIG failed because there was a hedge fund at the top of an insurance company. AIG failed because it was not a hedge fund, but a AAA rated highly rated regulated insurance company. This status gave false security to investors and counterparties. Hence the curse of the AAA, most of the institutions that ran into major trouble were AAA rated entities. Fannie, Freddie, AIG, monolines, GE all were AAA rated. Einhorn says he is betting against Moody’s (MCO). He describes the situation as such if your highest rating is a curse of those who have it what value do you have? If your goal is to destroy the brand would you do anything differently than Moody’s has done. Why reform them if we can get rid of them? Ratings system is inherently pro-cyclical and destabilizing. Regulators can improve the stability of the financial system by eliminating the ratings agencies. Company is 19x estimated earnings, balance sheet is upside down with negative shareholder equity.
Einhorn and his colleagues at Greenlight announced they were donating $7 Million of their profits from the Allied Capital short to charity.
Great stuff from the Ira Sohn conference!
See below for notes forwarded to me from a friend. If anyone else has Ira Sohn Conference notes and would like me to throw up on the blog, let me know.
I am amazed of some of the resources you can find out there if you know how to massage the Google Search. I was running a search on distressed debt portfolio management (for all you followers out there, the exact search was: "Distressed Debt Portfolio" filetype: pdf). What I found was a fascinating PDF entitled: "Risk Management for a Distressed Securities Portfolio" by Marti Murray. This is a great read for any distressed investor.
You can find the document here: Risk Management for a Distressed Securities Portfolio
This is a must read document for those interesting in distressed debt securities. One of the case studies is on the Worldcom/MCI Bankruptcy, which is a spectacular example of a complex bankruptcy where risk adjusted returns were there for those who did LOTS of digging.
Murray points out one of the keys of distressed debt analysis and bankruptcy investing is to determine the key drivers that will make or break an investment. Sometimes it is two or three variables, and sometimes it is significantly more. As a topical example, the bank debt of General Motors has been on a tear as of late (the revolver is 92, the term loan is 95 - both up 40-50 points from the lows). The two main drivers of that analysis were:
- Is the security granted for either the revolver or the term loan (they are different) greater than the amount of debt outstanding. Most market participants agreed that that was indeed the case.
- How much will the government crush you? That is where the discrepancy and the mismatch of price vs intrinsic value really came down to.
Stay tuned in the coming weeks for some interesting feature (more case studies, interviews, more profiles of distressed debt fund managers) we have been cooking up at Distressed Debt Investing.
For our next distressed debt example, I present to you (with the help of a friend) Blockbuster's bank debt (currently quoted 69-70).
- Rate set to LIBOR plus 10.00% (3.50% LIBOR floor)
- Maturity date extended to September 30th, 2010
- Size set to $250M (from $325M) with $52.5M available for LCs
- Amortization Schedule Set: December 15th, 2009: $25M, January 31st, 2010: $20M, February 28th, 2010: $20M, March 31st, 2010: $20M, April 30th, 2010: $10M, May 31st, 2010: $15M, June 30th, 2010: $50M, July 31st, 2010: $10M, August 31st, 2010: $10M
- 50% Excess Cash Flow Sweep established, Fixed Charge Coverage Ratio set to 1.25x up to January 3, 2010 and 1.30x thereafter
- Leverage Ratio amended to 2.75x (previously 3.00x)
- $30M Capex covenant in 2009 and $40M in 2010 (with a $10M carryover option); this is in-line with maintenance capex for the company.
- Removes “Going-Concern” default language resulting from FY2008 Auditor’s Opinion
I am working on a projecting involving a metals & mining company. If you are well versed in the topic and wouldn't mind taking a few minutes to answer my questions, please contact me at hunter [at] distressed-debt-investing [dot] com
If you remember a few weeks ago, we talked about a few steps in my due diligence process for researching potential short investments.
First of all, thank you all for participating in the Distressed Debt Investing Poll. Your feedback has been helpful in allowing me to better guage our reader's interest. As you can see from the poll results, Distressed Debt Investing is going to start zeroing in on distressed debt concepts and distressed debt case studies.