3.30.2010

Michael Burry Quotes

A week or so ago, we laid out a few of the better quotes we found from Michael Burry's Silicon Valley Thread. Unfortunately for me, I was beaten to the punch by a number of other fantastic bloggers that also went through his old writings and pieced together some of the stronger, more illuminating "Michael Burry quotes" from the thread. Well - as one not to be beaten (and remember, I reference Michael Burry in July 2009), I plan on writing a few posts on Burry drawing from the Silicon Valley thread as well as some of the more "off-the-radar" pieces out there. For example, I bet a number of you haven't seen this document: Burry on his RMBS short


I read the Burry thread chronologically - staying mainly on the Buffettology and Value Investing threads. The quotes I lay out will not be in chronological order though as my "Burry" document is over 30,000 words (and no, I will not post it).
IMO everyone thinks of their IRA/tax-advantaged accounts as the "sit back and forget about it" accounts. I have harped on this irony for years. Given my type of investing, you'd think it would have hit me like a ton of bricks, and it did. I am an aggressive unapologetic value-based trader in all my non-taxable accounts. Everyone should be. As Jim said, it's a big, exploitable advantage. I think even Buffett more or less said so when he said he could make 50% a year if he was smaller (I am guessing he might agree that most chip shots are of the microcap, and hence ben graham, variety.) In my taxable ones, I'm a bit more apologetic. If it fits one's personality and stock-picking ability, then the advantages are obvious to a buy and hold strategy, though.
I do not know how Dr. Michael Burry managed his fund (in terms of turnover). From his 1Q2001 letter:
To recap, January saw a rapid run-up in the value of your investment in the Fund. One competitive advantage of mine has been taking advantage of the fast times to raise cash for the next slow time, to rotate into less-appreciated securities, and occasionally to short into speculative excess. This can result in my investment strategy producing higher profit, higher turnover, and, yes, higher taxes. In the past, it has done so. In the future, I expect it to do so.
And further down in the Silicon Valley thread
It is Buffett, not Graham that espouses low turnover. Graham actually set targets: 50% gain or 2 years. That actually ensures rather high turnover.
So I venture a guess that he trades more than the stereotyped value investor. Many "value investors" should take notice of Burry's comments about exploiting the tax advantages of IRAs. From my perspective, given the amount of capital the majority of us our managing in our PAs, there are always 50 cent dollars out there just waiting to be scooped up.
When a stock is this misunderstood, and this many people have lost money on it, well, it's one of the better contrarian plays out there for the patient investor. And the patient investor should hope it goes lower, not curse the volatility.
How many times have you pitched an idea to a colleague or friend and just had it spit on? I am curious to see the relative performance of Value Investor Club or SumZero ideas with ratings less than a 4 or 5 respectively. Maybe in the microcosm that is the value investing community consensus is cheery, but I doubt it. Does it mean chasing after horrendous situations? And I respond: At what price? One of my favorite screens on Bloomberg is US stocks with at least five analyst ratings and the average rating less than 2 (on Bloomberg analyst ratings range from 1-5, 5 being strong buys, 1 being strong sells). Here is the list right now (excluding biotech for right now):
  • Post Properties (PPS) ... 1 buy, 2 holds, 12 sells
  • YRCW Worldwide (YRCW) ... 1 buy, 4 holds, 8 sells
  • Alon USA (ALJ) ...0 buys, 2 holds, 6 sells
  • K-Sea Transport (KSP) ... 0 buys, 3 holds, 5 sells
  • K-Swiss (KSWS) ... 0 buys, 2 holds, 3 sells
These are not well liked companies. In an issue of Value Investor Insight Jeffrey Tannenbaum of Fir Tree stated:
One of the first questions we ask about a possible investment is “Why is it mispriced?” If you don’t have a reason, there’s a good chance it isn’t really mispriced.
As WEB states, you pay a high price for a cheery consensus.

This ties in write with another of my favorite Burry quotes. Short and simple:
But who are you selling to? And what are they buying with?
I have a friend at a very well respected fund who's simple philosophy is he only buys situations where there is an uneconomic seller. While I will not take it this far, I understand the reasoning. We do not know who is on the other side of our trades or investments. Obviously it depends on the stock or market in which we participate, but there is a reason you can buy a security at today's market price: because there is a seller at that price. What does the seller know that you do not know? Is he just crazy? Is there a reason for his selling? Is it a temporary problem you that he views as permanent? Uneconomic sellers could mean companies dropping out of an index, fallen-angel bonds that need to be sold because accounts are unable to own high yield, a fund liquidating and putting pressure on a stock, a failed M&A deal, a situation that has become too complicated etc.

And, just to top it off...how about a full blown analysis of a stock from one of Dr. Burry's old writings:
May 18, 1999 (updated May 23, 1999): Silverleaf Resorts (NYSE: SVR) - Quick, first gestalt: time-share. Images of faded browns, unfashionably "retro" clothes and loud salesman fill my head. How about you? Well, now we have overtures of a growth industry. A pretty slick one too. Gone is "time-share." Now, we have "vacation ownership interest," or VOI. And forget those faded browns and past tenses. The story is much different, and it is happening right now. Big players such as Marriott and Disney have moved into the field, and the size of the VOI industry has more than doubled during the 1990's.

In fact, open-minded investors wishing to ride the biggest demographic trend to ever hit the US - the aging babyboomers - may have already stumbled onto this industry. It appears a good time - an entire industry's worth of stocks are in the dumps, and consolidation is in the cards with many players selling for at or below net asset value.

There is indeed value here, but the superficial numbers do not tell the whole story. One must dig a bit to understand.

There are several different types of operators in this field, and they appear to be accorded different valuations.

Despite the gross dissimilarities in returns, the general similarity in Price/Book ratios does suggest that the market is using current net asset valuations (note: book value is a decent proxy for net asset value, not its equivalent) to value these stocks rather than growth or return statistics. This makes sense, since the industry-standard way of accounting makes the growth and earnings numbers poor measures of value.

Silverleaf looks the cheapest. Notably, it is also by far the smallest market cap. This proves rather artifactual. If Silverleaf were accorded an industry multiple, it too would sit among the Trendwests and Vistanas in terms of market cap. So it really is not a size issue but rather a valuation issue.

And this is where it gets interesting. Silverleaf is an operator of "drive-to" VOI's. In other words, Silverleaf positions its resorts within reasonable driving distance from major metropolitan areas. The targets are middle-income customers, outside the targets of the Disney's and Marriott's. This greatly increases its potential customer base, and is a decent economic model that helps set Silverleaf apart from the crowd.

But the valuation is far from straightforward. Silverleaf is the cheapest of the bunch on both a price/earnings ratio and a price/book ratio basis. Its revenue gains are the greatest, but that is mainly due to a capital infusion in the form of $75 million in long-term debt last year. And the revenue gains are not sustainable without further capital infusions.

This is because Silverleaf, like other reputable VOI operators, typically books revenue at the time of sale of the interest, and matches expenses/costs of revenue generation to the period in which they are generated. However, most customers finance their purchase after a down payment, so Silverleaf is booking revenue that it has not yet received in cash. This is aggressive, and very important for intelligent investors to understand.

For instance, when a VOI is sold, the customer pays 10% down, and finances the rest over 7-10 years. However, for a given period, Silverleaf - using accrual accounting - books the entire purchase price as revenues. In addition, Silverleaf collects and books the interest received from customer notes receivable. There are also additional revenues from management fees for operating the resorts. But the key is that the principal payments - which will be received as installments over the next 7-10 years - have already been booked as revenue up front. This is aggressive accounting no doubt.

Because the remaining 90% of the principal has not been yet collected as cash, it goes into Silverleaf's accounts receivable. Silverleaf then uses the accounts receivable (the stream of future installment payments against principal) to secure up to 85% loan advances which it can use to help finance additional construction and development. These loans are the primary source of capital for Silverleaf. Other VOI operators use similar accounting. For instance, Fairfield regularly securitizes its accounts receivables to generate cash.

Because these loans are secured, the interest rates for such borrowings are lower, at a few percentage points over LIBOR, than they otherwise would have been. In fact, the weighted cost of Silverleaf's total borrowings including more expensive senior debt was just 9.1%, and interest income typical exceeds interest expense in any given period.

But in the most recent period, interest expenses amounted to a historically high 57.8% of the interest income received (via the steady stream of notes receivable). Blame the new, expensive long-term debt. Silverleaf cannot dip into that well repeatedly.

Now, there's the issue of inventories as well. What are they? The company's inventories are the VOI's it has either acquired, reacquired, or built but not yet sold. The inventories are on the books at the lower of cost or market price. The company did have a large amount of inventories acquired several years back at a low cost basis. It has depleted those, and is now selling out of inventory that it built at a higher cost. This is squeezing margins on VOI sales.

As well, management anticipates higher marketing expenses associated with several new ventures. The company may have miscalculated a bit and is being forced into stepping up marketing efforts more than it planned in order to sell interests in certain slower markets.

Future inventory will come from current inventory and VOI's not yet built. The wisdom of further long-term debt to finance this is questionable. So what happens when the company sells through its inventory and has maxed out its borrowing of 85% against accounts receivable at some reasonable level? The company's sales will basically crash. The lone recurring revenue will be net interest income (expiring over 10 years) and management fees.

The sum result is apparent in the company's cash statements, which show deepening negative free cash flow despite the record sales and earnings. Indeed, a risk factor listed in the firm's annual 10-K is "negative cash flow."

In an intended vote of confidence, the chairman, CEO, and majority shareholder Robert E. Mead has announced he will purchase up to half a million shares on the open market. The company's own share buyback plan has been stymied by covenants of its senior debt. So this is indeed a nice gesture, although he already owns over 50% of the outstanding stock.

Which brings us to a point that must be mentioned with regard to this inudstry - takeover valuations. As insinuated before, large players in the leisure industry such as Disney and Marriott are moving into VOI's. A confirmation of the demographic trends from some expert marketers, to be sure.

The greater meaning is obvious for players like Silverleaf which are trading well below book and up to a 50% discount from current net asset value. These are tantalizing numbers to would-be acquirers. In a takeover, just a fair price would be a big bump from current levels.

So given the inability to value this sector in terms of growth or simple ratios, the next step in the analysis is to figure out the current net asset value. We'll assume all liabilities are real, per Graham's instructions, and adjust the asset side of the balance sheet to reflect reality.

The inventories are recorded at cost. If we use recent history as a guide, those inventories are actually undervalued, as the company's cost of building VOI's is only about 1/7th of the amount received on sale. First, assuming conservatively that only 50% of the inventory is saleable, we get $40 million in saleable inventories. Allowing for the higher cost basis on more recent inventories, these will amount to nearly $200 million in sales. The present value of these sales would sit at about $160 million conservatively, or twice the recorded value.

According to industry standard the notes receivable have a securitizable value of about 15% more than their recorded value. This is due to the high 14+% interest rates charged to buyers. So the $198 million in accounts receivable could be adjusted to about $227 million. I'll stick with the $198 million figure to remain conservative.

The fixed assets are assumed worth 25% of stated value, cash is given full value, and minimal other assets are given 50% of stated value.

Using these adjustments, the adjusted total assets are actually about $400 million. Less total liabilities of $208 million, the net asset value sits around $192 million, or about $15 per share.

The market currently values the shares at about $97 million, or $7 1/2. Credit the huge disparity to the concentrated majority ownership - the market is betting that CEO and majority ownder Mr. Mead will not sell out. Still, the fact remains we have a dollar selling for about 50 cents. Makes one wonder when Mr. Mead himself will consider taking the company private rather than just buying a few shares.

The greater meaning is obvious for players like Silverleaf which are trading well below book and up to a 50% discount from current net asset value. These are tantalizing numbers to would-be acquirers. In a takeover, just a fair price would be a big bump from current levels.
A few takeaways from this:
  • Throughout the archives, I have found Dr. Burry to weigh heavily on relative valuation. For example, he would put up four or five companies in the same industry and gauge them on things like Price/Sales, EV multiples etc. Generally speaking - we all do this. But what he liked to do was to dig in and try to figure out WHY the market was pricing these companies where it was relative to the industry.
  • Burry also dug into the numbers of the companies he analyzed and tried to get a sense if the stated GAAP numbers were overstating or understating the true economic performance of a company.
  • Burry gives a reason for the market selling a dollar at fifty cents.
If you have any interesting Michael Burry quotes or writings you would like to share, please send them my way (hunter [at] distressed-debt-investing [dot] com).

4 comments:

Arthur O'Keefe 3/31/2010  

Hey, these are amazing writeups you're doing. Keep up the good work!

Arthur O'Keefe
www.spvalue.com

quest for value,  4/02/2010  

I find it a bit strange you would use a time share developer as an example of a great Burry idea. There was a reason it was selling far below stated value -- these types of developers were the first to be affected as the credit tide went out.

So what was Silverleaf's performance? I notice the symbol SVR is no longer in service and the similar SVRF doesn't take me back to '99..

P 1 4/06/2010  

Without more context, I am not sure you can say that this was a Burry investment idea. At face value, he is trying to explain why a company has a low price to book value.

Considering that he was a medical doctor, who at the time was practicing as an amateur value investor, I find his writing impressively rigorous. He shows near an analyst's level of understanding of the business and digs in deep to understand the valuation. Aggressive accounting for revenue recognition and negative cash flow definitely would make me hesitant to invest, but I admire his thoroughness.

I assume they went bankrupt or were bought by a private equity firm, and I didn't find which based on a quick search. I do see they are now trading as SVLF, but notice that ticker only goes back to 2004. What I see today is a company mostly accumulating debt, uneven revenues, and of course negative cash flow. Not my cup of tea unless it was trading for pennies against a valuation in dollars in a liquidity crisis I thought they would survive. Notice the huge discount to book value (even more pronounced now than in the original evaluation).

Dr Burry is practically my next door neighboor. Having read these articles I would really like to meet the guy.

Anonymous,  6/01/2011  

Could you post how one gets to the low rated US Stocks Bloomberg screen you mentioned "One of my favorite screens on Bloomberg is US stocks with at least five analyst ratings and the average rating less than 2 (on Bloomberg analyst ratings range from 1-5, 5 being strong buys, 1 being strong sells)."

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hunter [at] distressed-debt-investing [dot] com

About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.