Notes from Invest for Kids Chicago 2011

Here is all the action from Invest for Kids Chicago 2011. Enjoy!

Michael Milken – The Milken Institute
  • Milken noted that he would ot making specific predictions, but a thematic view of how he sees the world
  • Thinks it’s valuable to understand history, and, unfortunately, we never learn from history
  • Churchill said that when a solution to a problem is manageable it is always neglected
  • It is no surprise why Germany is winning in the EU, their unit labor cost are much less than all the PIIGS
  • Germany’s unemployment level is less than 6% vs 21% in Spain
  • Northern Europe has routinely the least amount of problems, and Southern Europe has the most
  • Valuable to look at 1) Perception vs Reality and 2) Capital Markets
  • Perception: What came first the chicken or the egg? The correct answer is egg. Reptiles were laying eggs before chickens existed, and the birds that layed the egg to the first chicken were not chickens.
  • You just need a different perspective on the problem to find the solution. Are we asking the right questions?
  • The U.S. surprisingly has grown it’s oil production more than any other country in the past 3 years. Volatility created alternative production. North Dakota is the 4th largest producing state. ~ 6% of crude output
  • Digital real estate is the important real estate. 6 billion digital phones in the world. Who is going to control the real estate?
  • Brazil: Manaus Brazil use to be the rubber capital of the world. Now it is an electronic manufacturing powerhouse. Foxconn is investing 12 billion in Manuas.
  • The world is moving east. Of the 50 largest GDP cities, 20 will be in Asia. Half of the European cities will drop of the list.
  • Asia has 59% of their population that is 20-34 years old. This is where production and demand will be.
  • The middle class is booming in China, Malasia, Thailand, Indonesia, Phillipines and India -This is where you need to invest.
  • Milken then moved on to his view of the capital markets by beginning with: What is the American Dream?
  • Access to capital is based on ability and not on social status.
  • Profit is a function of Financial Capital * (Human Capital + Social Capital + Real Assets)
  • Give capital to the productive people and employment booms. Figure out how to empower human capital. It is our largest asset as a nation.
  • In the 1920’s the automobile was innovation. 60% of the cost was raw materials and energy. Now innovation is the microchip which is less than 2% materials and energy.
  • It is too difficult to get into the U.S. which means we are losing the top minds. Other countries are getting the students that we will not let in. Australia and Canada, Singapore, and the U.K. are developing the best technology because they are talking more students from Asia.
  • An example of this is Hollywood. All of the 6 largest film studios were started by someone from within 50 miles from Warsaw, Poland. Think if we would not have let them in the country.
  • ½ of all growth is from medical research
  • 70% of health is lifestyle, 30% hereditary
  • The U.S. is the heaviest country on Earth 36.5% obese
  • 1 trillion spent annually on obesity in this country. Think if we could save this just by eating less and changing lifestyle (Apparently we can deep fry butter and dip it in bacon fat. That is why we are fat)
  • Education: U.S. spends 2% of income on Education (33% on housing), Asia spends 15% on education
  • Moving on to Credit: Credit is what counts. Not leverage. Equity is too small a fraction of assets. This has all happened before. All banks in Texas were AAA, but when the energy cycle busts they all defaulted. We need to be extremely careful how we deleverage because it is a multiple factor on the economy.
  • Loans to real estate: Real Estate does not always go up forever it never has. No one knows when interest rates will go up but they know that they will and the cost of homes will go up.
  • 4 companies are rated AAA. However, S&P found away to rate 1600 leveraged securities AAA.
  • Sovereign debt is by far the worst credit. They always default. Adam Smith noted that countries never pay their debts after they reach a certain point of leverage. Greece defaults 1 of every two years before they were in the euro zone.
  • 1974 is important year to study. Interest rates doubled. The market feels like 74. The Nifty Fifty went from a P/E of 66 to 11. Investors lost half their money. Investors flocked to money managers to manage their money. (They could no longer just get by investing int the Nifty Fifty)
Barry Sternlicht (Starwood Capital Group)
Idea: Housing. Homebuilders. Specifically Toll, NVR, Lowes, and HD
  • The world is volatile so you have to look for themes.
  • Residential real estate is where you want to be based on his view of the world.
  • The average amount of house starts for the last decade was 1.1 million per annum. Currently at 300-400k.
  • It could not be a better time to buy a house. Low interest rates. Low housing prices. It is cheaper to buy than rent for the first time.
  • People are doubling up in rentals. Multi-generational families are growing which is causing housing formation to slow. Lots of pent of demand for houses.
  • 3-3.5 million people enter the U.S. every year. This causes the need for 1 million to 1.5 million houses. We are only building 400k.
  • Foreclosures and delinquencies are trending down. Prices are coming up and stabilizing. If you drop out distressed sales from banks they are up. Appraisals are hard to come by in distressed communities.
  • Sees a rebound in housing starts. People will find a way to finance and buy homes given the demand.
  • You could buy levered names but for a turbocharged return but he prefers: Toll, Lennar, DR Horton, and NVR. Specifically, he really likes Toll and NVR
  • Toll: Caters to the haves (vs the have nots). Their world will recover first. 23% gross margins, and over a billion worth of inventory in favorable areas.
  • Also likes Lowes: LOW owns 90% of their real estate. Earnings will be much higher in a bull market. Not only will P/E rise, but E will rise. You cannot be replaced by the internet. You have to have a lumber yard etc. They have lower margins than HD which they can improve. 71% remodeling exposure. Buying back shares. Have already bought back 13%. Trades at a reasonable multiple. TEV/EBITDA of 6.5x. Can buy back 70% of shares in 4 years. (Reminds him of Teledyne)
Richard Perry (Perry Capital):
Ideas: Fannie and Freddie Preferred Securities and RBS Tier 1 Securities.
  • Fannie and Freddie are in conservatorship of the U.S. Government
  • The U.S. has invested $107 billion in Fannie and Freddie
  • The agencies have $34 billion in PFD, $19 raised in '07 and '08
  • Not a litigation situation but it is interesting to look back and see what the government said when the agencies raised those preferreds. It makes you think they may be liable.
  • The PFD trade at 8.5 cents on the dollar. This is an asymmetric risk/reward situation.
  • The government needs to balance their budget. Could increase guaranteed fees slightly (10 BPS), reopen the mortgage market, and spur the economy
  • A 10 BPS raise would result in a $30 billion dollar deficit reduction over 10 years. This helps the government
  • Could also convert to common and monetize the government stake
  • OMB could improve $65 billion to $150 billion by 2021
  • House Financial Services recommended increasing the guaranteed fees
  • Likes the asymmetric risk/reward return
  • Moving on t RBS Tier 1: 10 billion in non cumulative Tier 1 Securities (preferred). EU directed RBS to stop paying dividends through 4/2012. Pari passu “must pay” trade at a 25% to 35% premium to “may pay”. RBS is a restructuring story. Recapped during 2008. Current Tier 1 is 11.3% vs 4% in crisis. 95% loan to deposit, peaked at 154% in 2008. Liquidity portfolio of £170 is 121% of short term wholesale maturities. Sovereign exposure is £772 or 1.6% of Tier 1. Tail risk is supported by the UK gov which owns 82%. £50 bn equity injection by UK was junior to Tier 1. Dividend on common is not payable unless Tier 1 is paid. Large banks perpetual securities trade at 7% yield. Restoring dividends could save money by making the bank more acceptable to investors lowering interest costs. The preferred coupon is deminimus relative to £48 billion in core Tier 1 capital
Tom Russo – Gardner, Russo, and Gardner
Ideas: Large multinational parent companies (Nestle, Pernod Ricard, SAB Miller)
  • Thinking in terms of 10 year investments, not one year
  • If people think the S&P could go down because of Europe (13% of S&P revenue from Europe) they would not like his fund which is 70% in non U.S. companies, 30% in emerging countries
  • Europe is the place to be. Buy businesses that make their revenue away from Europe.
  • Global value investing – “is not for girlie men”L
  • Leading multinational firms benefit from: 1) Capacity to reinvest in high ROICS – corporate wide 2) No dividend burdens (opposed to subsidiaries which are in different companies) 3) Corp culture is knowable (ethics) 4) Corp governance 5) Global talent pool 6) Global best practices – SAB Miller uses their lessons learned in new markets 7) Low valuations are available (Europe is loathed) (revenues are not in Euros) 8) Reduce translation risk. (language barriers)
  • Likes when you can buy the global parent for a lower multiple than subs: Nestle, Unilever, British Tobacco
  • Value Strategy: Looking for 50 cent dollars, capacity to reinvest, capacity to suffer (in other words, a rock-solid balance sheet)
  • Nestle: Investing in countries with growing incomes leads to higher value added product revenues. A large ability to suffer (balance sheet). Stayed in Russia during ruble crisis
  • Pernod Ricard: Went to China. Large capacity to grow and invest. 15% of profits in China. Family controlled. Not thinking short term. India is a large opportunity in the spirit market
  • SAB Miller: Africa: Local brewed beer to bottled beer is a large opportunity in their own back yard. EBITDA margin is down, sales are up. Volatility permits reinvestment. Just bought Fosters.
  • Final thought: Money managers also need the capacity to suffer and stick with conviction in volatile markets.
Leon Cooperman: (Omega)
Ideas: Charming Shops, E*trade, KKR Financial.
  • Leon noted that Omega is normally a bottoms-up show but in this market you must address the macro environment to “set the table”
  • Currently there is record stock and sector correlation
  • Thinks the U.S. will avoid recession but will remain in a slow growth environment
  • "We need 3% growth to dent unemployment, 9% unemployed, 10% more underemployed"
  • All of the global unrest is a result is a result of the economic unrest, wealth disparity, and the uncertainty in government
  • We could see riots in US like Arab Spring and UK.
  • Europe: Expects ECB to execute bailout
  • Obama wants to tax workers and punish savers: 50% of people are on the public dole, do not want a change
  • 2012 will be a test. “If the president is in trouble, the market is in trouble”
  • By the Fed Model, equities are cheap. Yields are higher than interest rates. Average P/E is 15, average treasury yields 6%. Yields today are 3% and P/E is 12x.
  • Equities are cheap. They are the best house in the asset neighborhood.
  • The ten year could jump to 4-6% which would be a big loss in the bond world. Not the place to be. Rather be in credit than bonds. Rather be in stocks than credit
  • Charming Shops: Management needs to get out of Fashion Bug and sell Layne Bryant. No net debt. Lane Bryant alone worth 2x current stock price
  • E*Trade: Great business but invested in mortgage bank. 13.8 billion invested in mortgages. 700 million rolls of every quarter. Earning 80 cents per share. 100 million loan loss provision. 1.5 billion in debt yielding 9%. Improved credit could add 40 cents per share to earnings. A strategic M&A asset in the brokerage
  • KKR Financial: Dividend yield 9% covered 2x by earnings. 28% below book
Mark Lasry (Avenue Capital)
Ideas: GM and Hovnanian
  • GM: Had the largest market cap at one point a number of years ago $12.2 billion. In 2000 revenue surpassed Wal-Mart. Trades at 1x EV/EBITDA. People forget Apple needed a $150mm investment from MSFT. Now it is the largest company. Apple trades at $370 billion, with EBITDA of $35.6 billion. Avenue bought the bonds to create GM at 2x EBITDA now he is pitching it at 1x. US government owns 1/3 of GM, people are trying to find the right time so that they don’t buy in front of the government sale. Now is actually the right time to buy, when everyone knows the government is going to sell. Comps trade at 4-6x (Except Ford trades at 3.1x). So GM could go up 4x. Ford 3.1x, Honda 4.4x, Toyota 5.6x, Hyundai 5.9x.
  • Hovnanian: 7th largest home builder. Housing starts use to be 1.5 million, now 0.3-0.4 million. People will buy homes, the question is a matter of when. Interest rates are low, everyone wants to time it but they cannot. Buy the Senior Unsecured Bonds. Get paid to wait. HOV has a billion dollar NOL. Senior Notes trade at 35, current yield is 20%, (6.5 coupon). They have 350 million in cash on Balance Sheet. 1 billion dollars in land inventory. “Everyone knows this market will turn a question of when” You don’t need the economy to grow faster than 1% for this to work, their view is 1% is the most probable outcome. If Europe defaults this will go down, but you are getting paid to take that risk
Michael Elrad: (GEM Realty)
Idea: Class A malls, specifically Macerich
  • Can you invest with conviction in a volatile market?
  • GEM looks at investing in 3 stages: (Top down, bottom up, and hedging)
  • Their top down analysis led them to Class A malls. Only way to buy Class A malls is through public companies (Simon, Westfield, GGP, Macerich, Taubman). 5 public companies control 80% of the Class A malls
  • 15 years ago retailers were declining. In reality, the fittest retailers survived and now the standing retailers are stronger credits and tenants are more diversified.
  • Today tenants pay more rent and have better credit
  • Sales per square foot have rebounded from the 2008/2009 period
  • NOI has been stable, even though retail sales have been volatile
  • Lost very little occupancy during recession
  • Currently stocks are 20% below their estimate of fair value
  • Macerich is 10% discount to peers. Recommending a 3 year long in Macerich (MAC). Macerich has a 4.9% yield, NOI growth 3% in 2012. 84% of assets are class A. Debt is 45% of EV. 10% discount to big 5. Could be added to S&P. Destaggered board, could be a take out candidate. Approximate a 12% IRR over 3 years. 17% in upside case. To hedge short Class B properties and strip malls (50% hedge ratio)\
  • Do not need to hedge internet risk, because strong internet companies need Class A space to enhance their brand (Apple).
  • This is the future of retailing: "The show room for the online presence"
Barry Rosenstein (Jana Partners)
Idea: McGraw Hill
  • This ideas reminds him of the 1980s. Companies with great assets that fail to create value. 3 reasons: Complacent boards, family CEO asleep at the wheel, Empire building. Or all 3.
  • McGraw Hill: 4 groups: Ratings, Financial Data (CapIQ, Ratings Direct), Educational text Books, Platts
  • Stock manages to under-perform year after year
  • Capital allocation is inefficient
  • Education needs the most capital but has the lowest returns on assets and growth
  • Bloated cost structure because of conglomerate nature
  • Impossible for analysts to value the sum of the parts
  • Management has committed to buy back shares, and cut costs
  • There is more to do: Education is better on it’s own, can take leverage to lower cost of capital (can’t get rated because of S&P currently); Private equity could buy it
  • Platts could trade 5-6x turns higher than conglomerate value
  • They can take out $200 million of costs per year, 6-7 dollars per share in value
  • 15% of market cap buy back over 2 years
  • Break off Platts, Financial. Suitors include Bloomberg, Reuters. Could get a high teen multiple
  • Ratings business is not as bad as it seems. Regulation could make it harder for entry into the business. Real size of claims is smaller than people think. Small number of cases survive.
  • Should trade at $60 per share or 40% upside.
John Keeley Jr.
  • Focus on spin offs, below book value, distressed utilities, S&L conversions, and emerging bankrupt companies
  • Spinoffs drift: not in an index, institutions sell, Individuals sell, no street coverage
  • Case Study: Charles Tandy. Learned from all his spinoffs
  • Average 33 spinoffs per year
  • Idea is ITT: Jan 12 ITT separated into ITT, Xylem, and Exelis. Xylem is fairly valued, Exelis is undervalued. ITT has a good niche, is unlevered, can make bolt-on acquisition, and has room for multiple expansion.
  • S&L conversions: CFFN, ORIT, VPFG, RCKB, TBNK
  • S&Ls have to wait one year to pay dividends, 3 to be acquired
  • TBNK and VPFG are coming up on their 3rd year
  • Dodd-Frank is going to force all of these companies to look for an acquirer. These are the ones they like. Buy the package.
Sam Zell (Equity Group Investments)
  • Globalization has already happened. GDP of Emerging economies equals GDP of developed. The trend is only beginning.
  • Developed world has a Damacles sword hanging above it: Demographics
  • If your population grows, productive investments will follow
  • By 2050. Japan will be one to one. Retired vs. working. Sees no reason to invest in that environment
  • The developed world is “hungry”. People have aspirations. They are confident
  • Brazil: 25% of people in middle class. Going to 65%. Has 180 million people. Self Sufficient in food, energy, and water. Young and upwardly mobile population. Educated workforce. Brazil has pent up demand for products. 7 million houses under demand. Interest rates are high, inflation is high, expected returns are high. There is real demand for capital and that is why rates are high. Need to have a solid partner, cannot go in alone. Brazil reminds Zell of the U.S. in the 1950s. The people are extremely confident in themselves.
  • Trade rule of law for growth in developing countries. He is not ignorant to the risks.
  • Emerging markets are an extraordinary opportunity. Where do they need capital the most. Where are the highest returns?


Anonymous,  11/10/2011  

Thank you very much. This is excellent.

Anonymous,  11/18/2011  

Great, concise read. Much appreciated.


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.