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Archive for the ‘About’ Category

Guest post: Seahawk Drilling Inc (NASDAQ:HAWK) and the Hacienda

Posted in About, Seahawk Drilling (NASDAQ: HAWK), Stocks, tagged on August 10, 2010| 2 Comments »

I’ve recently run a few posts on Seahawk Drilling Inc (NASDAQ:HAWK) (see the post archive here). One of the major issues for HAWK is its Mexican tax dispute. It is a thorny, technical issue for which very few are adequately qualified to comment. Fortunately for holders of HAWK, I have found a practicing tax lawyer willing to provide some color to the matter. Andrew is an honors graduate of Harvard Law School currently practicing tax law in New York. He has over ten years of investment experience and is an avid reader of the value blogosphere and investment publications. His views are solely his own, do not constitute legal, tax or investment advice, and do not necessarily represent the views of any other person or organization.  Andrew welcomes comments and criticism and can be contacted at andrew48912 [at] gmail [dot] com.

Here’s Andrew’s take on HAWK:

Seahawk Drilling Inc. (HAWK) is a ~$100m company spun off from Pride International last year that has attracted considerable attention among value investors. HAWK’s business centers on renting out shallow-water jackup rigs, twelve of which are currently “cold-stacked” (inactive), to various drillers in the Gulf of Mexico and (when business is good) the Mexican coast.

Rather than analyze liquidation value, which Greenbackd did in multiple incisive posts, or discuss the company’s numerous challenges and opportunities, I examined tax issues discussed in HAWK’s recent filings. As a tax lawyer, I’m drawn to special situations involving complex tax issues.

Although there are tax issues with the CEO and directors’ stock compensation, and various tax assets and liabilities, these issues seem dwarfed by Mexican tax disputes.  Numerous posts have alluded to these disputes, but no one has tried to dig deeper (at least publicly) into how they may affect the company. I spent some time reading HAWK’s filings and exhibits in search of clues, and what I found surprised me.

Disputes with the Hacienda

HAWK’s most recent 10-Q states that the company is embroiled in several disputes with the Hacienda (the Mexican IRS), including:

a) Six disputes relating to tax years 2001 through 2003 totaling $97m.

b) Two disputes relating to tax years 2004 and 2006 totaling $42m.

c) Two Pride disputes relating to tax year 2003 totaling $5m, and

d) Several expected tax disputes for more recent years estimated to total $85m.

This represents estimated exposure of $229m, give or take foreign currency movements and any additional disputes.  $229m is a huge “scare” number, dwarfing the company’s reported cash of $48m as of 6/30 and ~$100m market cap, and so it seems likely to weigh on investor perceptions. But does it tell the whole story? I’m not so sure.

I have no special ability to predict the results of Mexican tax disputes,[1] and unfortunately the filings do not provide more guidance on the exact nature of the disputes, but there are more moving parts here. Before the spinoff, Pride and HAWK signed a Tax Sharing Agreement. The Agreement is included as an exhibit to the Form 10, and it addresses tax contests directly. More on that below.

The Tax Sharing Agreement

Under Section 2.1(b), Pride must compensate Seahawk for tax benefits allocated to Seahawk that Pride uses if such benefits arise from a pre-spin year and are used (a) to reduce Pride’s taxes in a post-spin year or (b) in the case of a tax contest or other dispute, to reduce Pride’s taxes in a pre-spin year. In a helpful move, the tax counsel set out an example of this compensation mechanic. This is great drafting, and I often wonder why more lawyers don’t do this.

The example says that if Seahawk has to pay Mexico as a result of a tax dispute attributable to the Seahawk business, Pride must amend its U.S. tax returns to the extent necessary to claim a foreign tax credit,[2] and must compensate Seahawk to the extent the credit is usable, either immediately if the credit can be used now or carried back, or, as it appears from the Agreement, in the future if the credit is used in a future year.

The foreign tax credit rules are very complex, and it’s not obvious whether the Mexican taxes at issue are creditable under U.S. law, or even if payments for a given year would generate tax credits that would be usable by Pride. However, the fact that Pride’s advisors chose to create a special provision for tax benefits attributable to tax contests and wrote an example to specifically illustrate this possibility as applied to a Mexican tax dispute is particularly striking. Agreements aren’t written in a vacuum – clients and lawyers discuss what should and shouldn’t be covered.

Why Things May Not Be As Bad As They Seem

Generally, foreign tax credits can be carried back one year and forward ten years (two and five for pre-2005 tax years), and refund claims must generally be made within ten years of the year to which the foreign tax payment relates.  If Pride can’t immediately use a credit, the present value of the credit is diminished, but this mechanism seems a potential way of mitigating the hit to HAWK of some of the Mexican judgments in a worst-case scenario.

In the absolute “best-case version” of this worst-case scenario, if credits were immediately usable by Pride and were allocated to Seahawk under the Agreement, requiring payments from Pride to Seahawk, payments to the Mexican tax authority for certain disputes could theoretically be “free” because the payments were offset one-to-one by immediately usable tax credits.[3] Moreover, the anticipation of needing to make a payment for which a compensating tax benefit payment by Pride may not arise until a future date could theoretically serve as a catalyst to dispose of less desirable rigs to provide interim liquidity. Such a sale could potentially generate taxable income to utilize tax benefits and put optimistic assessments of liquidation value to the ultimate test.

But what if HAWK wins?

Alternatively, there are scenarios in which the Mexican judgments could be a non-issue. HAWK could conceivably win some or all (as they appear to have done at a lower court in one dispute currently in appeals) of the cases. As another possibility, because the 10-K states that certain disputes are against subsidiaries that lack net assets or material operations, it appears conceivable that Mexico could be unable to collect in certain cases even if it does win (though query whether this could create politically-sensitive issues with respect to future rig business from state-owned Pemex).

With all these moving parts, it’s surprising that there is no direct discussion in HAWK’s filings that tax payments in the Mexican disputes could yield offsetting tax benefits. Rather, the 10-Q simply sets out the estimated maximum gross exposure without its connection to the Agreement, and only separately points out that the Agreement requires each party to reimburse the other in the event of a tax benefit arising from a tax dispute. I think it is unlikely that many people have taken the time to parse the interaction between the Agreement and the ongoing disputes, and I wonder if many investors are overweighting the disputes in their valuation of the company.

Conclusion

Taxes alone should (almost) never be the catalyst for an investment.  Without higher rig utilization, a favorable liquidation, or an asset sale, the cash burn could overwhelm the company, and potential tax benefits generally can’t save a firm if the underlying business model is unsustainable. HAWK is a highly risky play in a sea (or Gulf) of question marks, but one for which the risk may be justified by margin of safety and possibly significant upside, if one can stomach the volatility.

The author is currently long HAWK.

This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security

[1] It should be noted that the most recent 10-Q of Hercules Offshore, a competitor of HAWK’s, reports that Hercules settled multiple Mexican tax disputes for approximately $10.8m. Although both Hercules’ and HAWK’s filings mention that the disputes involve Mexican tax deductions, the extent of any issue overlap is unclear.

[2] In general, and with considerable limitations, a U.S. taxpayer may claim a foreign tax credit for foreign taxes paid with respect to activities carried out in a foreign branch, and may claim an “indirect” foreign tax credit upon repatriation of earnings from a foreign subsidiary in which it holds sufficient ownership.

[3] It should be noted, however, that Pride reported $25.5m in foreign tax credits of its own on its last 10-K which begin to expire in 2017. Therefore, it is unclear whether any tax benefits would be immediately usable by Pride for the tax year in which the benefit ultimately relates, or even during the carryback or carryforward period allowed under U.S. tax law, but the fact that Pride does not record a valuation allowance against its existing U.S. deferred tax assets suggests that Pride expects future profitability to allow it to use its tax benefits at some point.

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Kirk Report on James Altucher

Posted in About, Value Investment, tagged on August 9, 2010| Leave a Comment »

The Kirk Report has an enjoyable interview with James Altucher, managing director of Formula Capital, an asset management firm and fund of hedge funds, and author of four books on investing: Trade Like a Hedge Fund, Trade Like Warren Buffett, SuperCash, and The Forever Portfolio. I’ve extracted below several of my favorite parts:

Kirk:  … When and how did your interest in the market begin?

James Altucher:  From 1995 – 2000 I was building websites for entertainment companies. I built websites for HBO, Miramax, New Line Cinema, Loud Records, Bad Boy Records, Interscope, etc. It was the best time of my life. For HBO, for instance, I did a website called “3am” where I spent all my time interviewing drug dealers, prostitutes, homeless, whoever I could find at 3 in the morning in NYC. Other entertainment companies wanted that kind of flavor and suddenly I was doing websites for almost every media company in the city. The company I started, Reset, built up to about 50 employees and then we sold it. So I had some money which I promptly invested in Internet companies. All in the bust. So I decided I needed to learn more about the stock market.

…

Kirk:  What would you say is one of the most important lessons you learned early on?

James Altucher:  The only three things that are important are discipline, persistence, and psychology. Without those three things there isn’t a strategy in the world that will work for you. With those three things, just about any strategy will work.

…

Kirk:  …So, how has your approach toward the markets changed and improved over the years?

James Altucher:  No human or strategy can consistently beat the market. The best traders I know are some of the most humble guys out there and have no arrogance on their market opinions at all. They are able to switch opinions and strategies very quickly. I would say that over the years any arrogance I had about any strategy has probably disappeared and now I’m appreciative of just about any strategy out there as long as it comes with persistence, discipline, and positive psychology.

And, purely because it made me laugh out loud in the traditional, offline sense, extracted below from Go Ahead, Hate Me. I’ll Still Help You Make Money (subscription required), which Altucher links to as “7 reasons to hate me”:

Or when I went on CNBC once there was a Yahoo message board poster saying, “There was some homeless looking guy named James Altucher recommending stocks on CNBC today. Pretty cool of CNBC”

Read the interview.

P.S. I saw this Kudlow Report debate between Altucher and John Hussman of Hussman Funds in June and I’ve been trying to find an appropriate place to run it. Altucher believes the market is heading to 1,500 – watch Hussman’s face when he says “1,500” – while Hussman argues that the economy is in some trouble according to the ECRI and other indicators. The two debate back and forth, unable to agree, until Kudlow says words to the effect, “Give us your strategy. What would you buy right here?” Altucher says, “Exxon at 4 times earnings, Microsoft at 10 times next year’s earnings, IBM at 10 times next year’s earnings, Cliffs Natural Resources, makes iron ore, at 4 times earnings. These companies are cheap.” Hussman says, “I don’t mind James’ picks. They sound like reasonably valued stocks relative to the rest of the market.” I find it interesting that they can diverge on the economy and the market, and still come close to agreeing on individual stocks. See the debate.

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Classic Value Investors on NSACAR stocks ISCA and DVD

Posted in About, Activist Investors, Stocks, tagged , on August 6, 2010| 1 Comment »

I’m a huge fan of Mariusz Skonieczny’s work at Classic Value Investors, LLC. He’s recently written up the value proposition for International Speedway Corporation (NASDAQ:ISCA), Speedway Motorsports (TRK), and Dover Motorsports (NYSE:DVD). I think NASCAR is a great business. I’ve previously covered an activist filing for DVD, and I think ISCA is one of the cheapest genuine business franchises available in the market right now. I had been mulling my own post on ISCA, but Mariusz beat me to the punch, and I don’t think I can add anything else to his excellent post on NASCAR:

Famous drivers race against each other all over the United States and they only race at events sanctioned by NASCAR. Huge crowds attend these races and pay for admission tickets, food, and drinks. Advertisers pay big bucks to reach these crowds and television stations fight over the rights to broadcast NASCAR races.

Unfortunately, you cannot directly own NASCAR (National Association for Stock Car Auto Racing) because it is a private company controlled by the France family. However, you can own it indirectly through International Speedway Corporation (ISCA), Speedway Motorsports (TRK), or Dover Motorsports (DVD). I have written reports about International Speedway Corporation and Dover Motorsports.

NASCAR is a sanctioning body that controls who gets what race dates and when. For example, there are 38 Sprint Cup races, and NASCAR decides which facility gets which race. Companies like International Speedway Corporation, Speedway Motorsports, and Dover Motorsports own speedway facilities and are assigned Sprint Cup dates on an annual basis. While NASCAR can change these dates, it rarely does so. International Speedway Corporation has 21 out of 38 Sprint Cup races. One of them, LifeLock 400, is in the Chicago market, and I recently attended it.

While the experience was incredible, I went to the race to see why people go to these events and why sponsors and advertisers want to be part of the sport. While we were pulling in to our parking spot, it became clear that NASCAR is not just about racing. People attend races for the entire experience. Yes, they want to cheer on their favorite drivers, but also they want to tailgate and grill hamburgers and hot dogs, eat pizza, drink beer, throw a football, and get together with their friends. It’s not just a race; it’s family entertainment. Race fans are very loyal to the sport and they show it by the clothes they wear, the flags on their trucks, and even the tattoos on their bodies. When someone is willing to tattoo the symbol of the sport on his or her body, as this woman was (see left photo), you know you have something special. As of now, I have never met anyone with a tattoo of my name or my company’s logo. The day that I see it, I will know that I have made it big.

The enthusiasm of the fans is not the only thing that draws advertisers – race fans are extremely brand-oriented. They know exactly who sponsors the race series and the teams of their favorite drivers. They buy products from the companies that sponsor the sport because they know that operating a race team is expensive and racing teams rely on sponsors to keep them afloat. Race fans don’t mind being exposed to advertising. NASCAR is advertiser’s paradise, and as a result, cars, drivers’ uniforms, and speedway facilities are covered with advertising. Television stations want to broadcast events because they know that they can sell advertising spots to businesses wanting to reach home viewers.

What is interesting about companies such as International Speedway Corporation is that even though they own many speedway facilities, each of these facilities act almost as a separate business because they are located in different markets. For example, LifeLock 400 takes place in the Chicago market and doesn’t really compete against Daytona 500. As the owner of LifeLock 400, International Speedway Corporation has the exclusive rights to host a NASCAR race in the Chicago market. There is no one else who has this right. There is no competitor. You and I could build a race track in this area but it would be a big waste of money because we could not host a NASCAR race without having a race date, and getting one is not like applying for a drivers’ license. If we wanted to host a Sprint Cup race, which is the most popular NASCAR series, we are out of luck because as I mentioned before, there are only 38 of them and they all are already assigned to other tracks. We could buy one from someone but there are only five left that do not belong to International Speedway Corporation or Speedway Motorsports. The price tag for one Sprint Cup date is about $150 million, based some historical transactions.

Read the post at Classic Value Investors.

No position at the time of writing, but I am considering a long position in ISCA or DVD.

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Quant funds don’t perform like a good quant fund should

Posted in About, Quantitative investment, Stocks, tagged on August 5, 2010| 5 Comments »

I burned some digital ink on these pages discussing the utility of quantitative investment processes over more qualitative approaches. The thesis was, in essence, as follows:

  1. Simple statistical models outperform the judgements of the best experts
  2. Simple statistical models outperform the judgements of the best experts, even when those experts are given access to the simple statistical model.

The reason? Humans are fallible, emotional and subject to all sorts of biases. They perform better when they are locked into some process (see here, here, here and here for the wordier versions).

I also examined some research on the performance of quantitative funds and their more qualitative brethren. The findings were as one might expect given the foregoing:

[Ludwig] Chincarini [the author] finds that “both quantitative and qualitative hedge funds have positive risk-adjusted returns,” but, ”overall, quantitative hedge funds as a group have higher [alpha] than qualitative hedge funds.”

All well and good. And then Morningstar spoils the party with their take on the matter:

The ups and downs of stocks since the credit crisis began roiling the equity markets in 2007 haven’t been kind to most stock-fund managers. But those who use quantitative stock-picking models have had an especially difficult time.

What went wrong?

Many quant funds rely primarily on models that pick stocks based on value, momentum, and quality factors. Those that do have been hit by a double whammy lately. Value models let quants down first. Stocks that looked attractive to value models just kept getting cheaper in the depths of the October 2007-March 2009 bear market. “All kinds of value signals let you down, and they’re a key part of many quant models,” said Sandip Bhagat, Vanguard’s head of equities and a longtime quant investor.

Morningstar quotes Robert Jones of GSAM, who argues that “quant managers need more secondary factors”:

Robert Jones, former longtime head of Goldman Sachs Asset Management’s large quant team and now a senior advisor for the team, recently asserted in the Journal of Portfolio Management that both value and momentum signals have been losing their effectiveness as more quant investors managing more assets have entered the fray. Instead, he calls for quant managers to search for more-sophisticated and proprietary measures to add value by looking at less-widely available nonelectronic data, or data from related companies such as suppliers and customers. Other quants have their doubts about the feasibility of such developments. Vanguard’s Bhagat, for example, thinks quant managers need more secondary factors to give them the upper hand, but he also wonders how many new factors exist. “There are so many smart people sorting through the same data,” he said. Ted Aronson of quant firm Aronson+Johnson+Ortiz is more blunt: “We’re not all going to go out and stumble on some new source of alpha.”

Jones’s comments echo Robert Litterman’s refrain (also of GSAM) in Goldman Sachs says P/B dead-as-dead; Special sits and event-driven strategies the new black. Litterman argued that only special situations and event-driven strategies that focus on mergers or restructuring provide opportunities for profit:

What we’re going to have to do to be successful is to be more dynamic and more opportunistic and focus especially on more proprietary forecasting signals … and exploit shorter-term opportunistic and event-driven types of phenomenon.

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Wilbur Ross on Charlie Rose

Posted in About, Activist Investors, Contrarian investment, Liquidation, Liquidation Value, Net Current Asset Value, Stocks, tagged on August 4, 2010| 5 Comments »

Charlie Rose has a fantastic interview with Wilbur Ross, who played Willy Tanner (the dad) on Alf before becoming an investor in distressed businesses, most notably in the coal, steel and auto parts industries. This profile describes Ross’s start thus:

In 2001, when LTV, a bankrupt steel company based in Cleveland, decided to liquidate, Ross was the only bidder. Ross suspected that President Bush, a free trader, would soon enact steel tariffs on foreign steel, the better to appeal to prospective voters in midwestern swing states. So in February 2002, Ross organized International Steel Group and agreed to buy LTV’s remnants for $325 million. A few weeks later, Bush slapped a 30 percent tariff on many types of imported steel—a huge gift. “I had read the International Trade Commission report, and it seemed like it was going to happen,” said Ross. “We talked to everyone in Washington.” (Ross is on the board of News Communications, which publishes The Hill in Washington, D.C.)

With the furnaces rekindled, LTV’s employees returned to the job, but under new work rules and with 401(k)s instead of pensions. A year later, Ross performed the same drill on busted behemoth Bethlehem Steel. Meanwhile, between the tariffs, China’s suddenly insatiable demand for steel, and the U.S. automakers’ zero-percent financing push, American steel was suddenly red hot. The price per ton of rolled steel soared, and in a career-making turnaround, Ross took ISG public in December 2003.

…

After pulling off a quick turnaround in the twentieth century’s iconic business—steel—Ross set about doing the same with the troubled iconic industry of the nineteenth century. In October 2003, he outdueled Warren Buffett for control of Burlington Industries, a large textile company that failed in late 2001. In March 2004, he snapped up Cone Mills, which, like Burlington, was based in Greensboro, North Carolina, and bankrupt. As with the steel companies, the PBGC took over some of the pensions, the unions made concessions, and thousands of laid-off workers were recalled. Most important, debt was slashed. Today, International Textile Group has just about $50 million in debt, less than the two companies were paying in interest a few years ago.

In the Charlie Rose interview Ross discusses his analysis of LTV, which is basically a classic Graham net current asset value analysis:

Ross: We’re in the business not so much of being contrarians deliberately, but rather we like to take perceived risk instead of actual risk. And what I mean by that is that you get paid for taking a risk that people think is risky, you particularly don’t get paid for taking actual risk. So what we had done we analysed the bid we made, we paid the money partly for fixed assets, we basically spent $90 million for assets on which LTV had spent $2.5 billion in the prior 5 years, and our assessment of the values was that if worst came to worst we could knock it down and sell it to the Chinese. Then we also bought accounts receivable and inventory for 50c on the dollar. So between those combination of things, we frankly felt we had no risk.

Charlie Rose: And then next year you bought Bethlehem.

Ross: Yes, but before that even, what happened, out came BusinessWeek asking, “Is Wilbur Ross crazy?”

…

The joke was, right when everybody was saying, “This is too risky. It’ll never work,” the big debate in our shop was, “Should we just liquidate it and take the profit or should we try to start it up?” That’s how sure we were that we weren’t actually taking a risk, but I wanted to start it up because if you liquidate it you make some money, but you wouldn’t change the whole industry and you wouldn’t make a large sum as we turned out to do.

Watch the interview.

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Fortune on David Sokol

Posted in About, Warren Buffett, tagged , , , on August 3, 2010| 1 Comment »

Fortune magazine has a great profile on David Sokol, Warren Buffett’s Mr. Fix-It:

Buffett first met Sokol in 1999 when Berkshire was buying MidAmerican, the Iowa utility. With longtime Buffett friend Walter Scott, Sokol had bought a small, $28-million-a-year geothermal business in 1991 and built it into that utility powerhouse. MidAmerican, headquartered in Des Moines, now represents an $11.4 billion slice of Berkshire’s revenue (about 10%), and Sokol is its chairman. In 2007, Buffett asked Sokol to get Johns Manville, an underperforming roofing and insulation company, on track, and he did; he is now its chairman. In 2008, Charlie Munger, Buffett’s vice chairman, asked Sokol to fly to China to conduct due diligence on BYD, a battery and electric car maker. Sokol liked what he saw, and Berkshire invested $230 million for 10% of the company. That stake is now worth around $1.5 billion. In April, when Buffett had concerns about a provision in the Senate financial regulation bill that would have required Berkshire and other companies to post billions of collateral on their existing derivatives, it was Sokol he sent to argue his case. Buffett’s side of the argument won.

Last summer Buffett handed Sokol perhaps the biggest assignment of his career: turning around NetJets. The fractional-ownership jet company last year lost $711 million before taxes — not the kind of performance that warms Buffett’s heart. Today the company is profitable, and Fortune got a rare, exclusive view of how Sokol did it

This story about Berkshire’s attempted acquisition of Constellation Energy is superb:

The day after Lehman collapsed in September 2008, David Sokol noticed that the stock of Constellation Energy, a Baltimore utility, was plummeting. He called his boss, Warren Buffett, and said, “I see an opportunity here.” Buffett, who had noticed the same thing, replied after a brief discussion: “Let’s go after it.”

Constellation (CEG, Fortune 500) held vast amounts of energy futures contracts that had gone sour, and the company appeared to be on the verge of bankruptcy. Sokol, as chairman of the Berkshire subsidiary MidAmerican Energy Holdings, knew the utility industry and saw a chance to buy solid assets at a bargain price. The deal, however, had to be done within 48 hours or the company would have to file for bankruptcy.

Sokol phoned the office of Constellation CEO Mayo Shattuck III, who was in an emergency board meeting. When his assistant answered, Sokol told her he’d like to speak to him. The secretary replied that if she interrupted the meeting, she might lose her job. Sokol replied, “If you don’t interrupt the meeting, you might lose your job.”

Sokol boarded a Falcon 50EX and sped to Baltimore. He met with Shattuck and struck a deal that evening to buy the company for $4.7 billion, staving off bankruptcy.

Within weeks, before the acquisition was completed, Constellation’s board received a competing bid from Électricité de France for about a 30% premium. The board liked the offer, and so did Sokol — who walked away with a $1.2 billion breakup fee for Berkshire.

Read the article.

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WSJ profile of Li Lu

Posted in About, Stocks, Warren Buffett, tagged , , , , on August 2, 2010| 2 Comments »

The WSJ has a more full profile of Li Lu (subscription required), the Chinese-born hedge-fund manager in line to become a successor to Warren Buffett at Berkshire Hathaway Inc.:

Mr. Li, 44 years old, has emerged as a leading candidate to run a chunk of Berkshire’s $100 billion portfolio, stemming from a close friendship with Charlie Munger, Berkshire’s 86-year-old vice chairman. In an interview, Mr. Munger revealed that Mr. Li was likely to become one of the top Berkshire investment officials. “In my mind, it’s a foregone conclusion,” Mr. Munger said.

The profile discusses Li Lu’s investment in BYD:

The Chinese-American investor already has made money for Berkshire: He introduced Mr. Munger to BYD Co., a Chinese battery and auto maker, and Berkshire invested. Since 2008, Berkshire’s BYD stake has surged more than six-fold, generating profit of about $1.2 billion, Mr. Buffett says. Mr. Li’s hedge funds have garnered an annualized compound return of 26.4% since 1998, compared to 2.25% for the Standard & Poor’s 500 stock index during the same period.

…

Mr. Li’s big hit began in 2002 when he first invested in BYD, then a fledgling Chinese battery company. Its founder came from humble beginnings and started the company in 1995 with $300,000 of borrowed money.

Mr. Li made an initial investment in BYD soon after its initial public offering on the Hong Kong stock exchange. (BYD trades in the U.S. on the Pink Sheets and was recently quoted at $6.90 a share.)

When he opened the fund, he loaded up again on BYD shares, eventually investing a significant share of the $150 million fund with Mr. Munger in BYD, which already was growing quickly and had bought a bankrupt Chinese automaker. “He bought a little early and more later when the stock fell, which is his nature,” Mr. Munger says.

In 2008, Mr. Munger persuaded Mr. Sokol to investigate BYD for Berkshire as well. Mr. Sokol went to China and when he returned, he and Mr. Munger convinced Mr. Buffett to load up on BYD. In September, Berkshire invested $230 million in BYD for a 10% stake in the company.

BYD’s business has been on fire. It now has close to one-third of the global market for lithium-ion batteries, used in cell phones. Its bigger plans involve the electric and hybrid-vehicle business.

The test for BYD, one of the largest Chinese car makers, will be whether it can deliver on plans to develop the most effective lithium battery on the market that could become an even bigger source of power in the future. Even more promising is the potential to use the lithium battery to store power from other energy sources like solar and wind.

Says Mr. Munger: “The big lithium battery is a game-changer.”

BYD is a big roll of the dice for Mr. Li. He is an informal adviser to the company and owns about 2.5% of the company.

Mr. Li’s fund’s $40 million investment in BYD is now worth about $400 million. Berkshire’s $230 million investment in 2008 now is worth about $1.5 billion. Messrs. Buffett, Munger, Sokol, Li and Microsoft founder and Berkshire Director Bill Gates plan to visit China and BYD in September.

As impressive as that investment is, the WSJ says that Lu’s record is unremarkable without the investment in BYD:

But hiring Mr. Li could be risky. His big bet on BYD is his only large-scale investing home run. Without the BYD profits, his performance as a hedge-fund manager is unremarkable.

It’s unclear whether he could rack up such profits if managing a large portfolio of Berkshire’s.

What’s more, his strategy of “backing up the truck,” to make large investments and not wavering when the markets turn down could backfire in a prolonged bear market. Despite a 200% return in 2009, he was down 13% at the end of June this year, nearly double the 6.6% drop in the S&P-500 during the period.

…

Mr. Li declined to name his fund’s other holdings. Despite this year’s losses, the $600 million fund is up 338% since its late 2004 launch, an annualized return of around 30%, compared to less than 1% for the S&P 500 index.

Read the article.

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Peltz files 13D for Family Dollar Stores Inc (NYSE:FDO)

Posted in About, Activist Investors, Value Investment, tagged , on July 30, 2010| Leave a Comment »

Nelson Peltz’s Trian Fund Management has disclosed a 6.6% stake in Family Dollar Stores Inc (NYSE:FDO). The Purpose of Transaction item on the 13D discloses fairly standard boilerplate, although a buyback seems to be in the plans:

The Filing Persons acquired the Shares and Options (collectively, “Issuer Securities”) because they believe that the Shares are currently undervalued in the market place and represent an attractive investment opportunity. The Trian Group has met with Howard R. Levine, Chairman of the Board and Chief Executive Officer of the Issuer and members of senior management of the Issuer to discuss the Issuer’s business and strategies to enhance value for the Issuer’s shareholders. During these discussions, the Trian Group communicated its view that there is an opportunity to enhance shareholder value by improving the Issuer’s operational performance. The Filing Persons look forward to working with the Issuer on operating initiatives such as increasing sales per square foot to peer levels, improving the Issuer’s operating leverage and optimizing the number of new store openings. The Trian Group also discussed how the Issuer could utilize its capital structure and significant free-cash flow, including by considering the use of prudent amounts of leverage to increase the size of the Issuer’s stock repurchase program. In addition, the Trian Group provided examples of previous investments they (and/or entities affiliated with them) made in which they had helped create significant value by working together with management teams and boards of directors to improve operations and cash flows and enhance shareholder value.

Says the NYTimes.com in an article:

Family Dollar has been one of the retailers to benefit from the recession as more consumers come into its stores hunting for bargains. Family Dollar has seized on the opportunity, expanding its food offerings, lengthening store hours and accepting food stamps in all its stores. Peltz’s investment arm, Trian Fund Management LP, owns large stakes in a variety of major American businesses including upscale jeweler Tiffany’s & Co., food company H.J. Heinz Co. and fast-food chain Wendy’s/Arby’s Group Inc., of which Peltz serves as chairman.

FDO has been an extraordinary stock since the late 70s. It’s up around 24,000% excluding regular dividends. The last 5 years have not been as kind to the stock price, but it hasn’t been a disaster for shareholders either – the stock’s up 55% and the company has paid an increasing, regular quarterly dividend. It’s a situation worth watching.

No position.

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KKR cheap on a sum-of-the-parts basis?

Posted in About, Stocks, Value Investment, tagged on July 29, 2010| 3 Comments »

Barron’s has some interesting “sum-of-the-parts” analysis on the publicly traded limited partnership units of KKR & Co. L.P. (NYSE:KKR). Says Barron’s:

KKR ran $55 billion in assets across a variety of strategies as of March 31. Simply valuing the management fee stream from these assets at a 15 price-to-earnings multiple, in line with other money managers, and placing a lower multiple on its capital-markets unit, yields $3.25 or so per share in value, fully taxed. Adding the straight book value of its private and public direct investments produces another $6.25 per share, for a total implied value of $9.50, right at the present share price.

The next trick is valuing potential future performance fees on the $27 billion of deals housed in its private-equity funds, as well as those of deals not yet done and funds not yet raised.

One hedge-fund manager who has been buying the stock pencils in as plausible an 8% annual gain in the private funds, calculates the present value of the resulting performance fees (or the 60% of performance fees that flow to shareholders after employees get their taste) and gives this line item a 10 multiple to arrive at $3.70 a share in value. That produces a total sum-of-the-parts target above $13, more than 35% above the current price.

Analysts at Keefe Bruyette & Woods go even further, figuring KKR’s operating business to be worth $9 to $11 per share and the private-equity portfolio worth another $6.22 atop that, for a total value between $15.22 and $17.22.

Read the article.

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T2 Partners on BP, MSFT and BUD

Posted in About, Stocks, tagged on July 28, 2010| 1 Comment »

Market Folly has T2 Partners’ presentation to the 7th Annual Value Investing Seminar, in which they discuss three opportunities in BP, which I’ve discussed in the past, MSFT and BUD. Says Jay:

On Anheuser-Busch InBev, T2 Partners says, “you can currently buy BUD with an entry FCF yield of 10% for a business that can probably grow at GDP + inflation for a long time, giving you a long term IRR of at least 15% without any multiple expansion.” We’ve previously covered a separate and specific T2 Partners presentation on BUD worth checking out as well.

Secondly, Tilson and Tongue argue that Microsoft (MSFT) is undervalued. They write, “MSFT’s closing price on 7/12/10: $24.83, so assuming $2.40/share of FY 2011 earnings (midpoint of analysts’ estimates and our own), plus $4 share in cash, here are possible stock prices and returns (plus there’s a 2.1% dividend): 10x multiple = $28 stock = 13% return. 12x multiple = $33 stock = 33% return. 15x multiple = $40 stock = $61% return.” They highlight the company has $4.24 cash per share, shareholder friendly capital allocation (buybacks & dividend), as well as a new product cycle in tow (Microsoft Office, Windows 7, etc). T2 Partners says that the rumors of Microsoft’s demise are greatly exaggerated.

See the T2 presentation.

No positions.

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