Friday, 22 June 2012

A Summary of "What Makes Countries Rich or Poor?", by Jared Diamond

Jared Diamond, a Professor of Geography at UCLA and one of the world's foremost public intellectuals, is the author of the acclaimed Guns, Germs and Steel and Collapse.  Diamond is a leading expert on the fascinating and flourishing field of economic geography.  In a recent piece in the New York Reviewof Books, he reviews Why Nations Fail: The Origins of Power, Prosperity,and Poverty, by Daron Acemoglu and James Robinson.  The title of his review, "What MakesCountries Rich or Poor?", is in fact one of the basic questions in economics.

The authors conclude that the striking differences between rich and poor economies is explained to a large degree by the differences in institutions between economies, which provide incentives for people to work hard, become more productive and grow wealthier.  For example, the right to private property, reliable enforcement of legal contracts, stable economies, financial markets and currencies etc.
The authors make this case in part by observing "border" case studies, where geography and the ethnic background of the local population are largely the same, but the economies are very different, such as between North and South Korea.  There's a strong correlation between which countries are rich today and which have had a strong, centralized government for the longest period of time in the past, though patterns of colonization and the presence of natural resources are also important factors.
Diamond concedes that institutions matter - accounting for, he estimates, about 50% of the answer - but he believes that the authors don't adequately emphasize the importance of geography.  For example, some countries with poor institutions are nonetheless richer than more honest nearby nations, and a number of countries with solid institutions remain poorer than more corrupt counterparts.
Tropical locales, regardless of the quality of institutions, tend to be poor, because of the prevalence of disease and unproductive agriculture.  Parasitic diseases, and the flies and mosquitos that spread them, aren't killed regularly by a cold winter, causing devastating sickness that saps the power of local economies.  In addition, agriculture is less productive, again thanks to diseases and pests, and also because of differences in plant characteristics, historical patterns of glacial freezing, and the effect of temperature on organic matter.
Physical proximity to oceans and major rivers also help to explain differences in economic circumstances.  It's no coincidence that the poorest nations in South America and Africa are all fully or partly landlocked.  Finally, many countries that have suffered devastating environmental problems - especially damage to soil, water, forests and fisheries - also find themselves poor in consequence.
Though Diamond agrees with the authors that the history of a country's institutions matters, he argues that they underestimate the effect that geography had on making some nations amenable to stable institutions in the first place.  For example, Europe's many rich cities and countries arose out of the Fertile Crescent, a highly productive area of agricultural land.  Productive farmland allowed not just for sustenance but surplus supplies of food, which enabled some people to work outside of agriculture, allowing for the formation of central governments.
Diamond's long review will give readers interested in economics, geography or human development a broad but detailed understanding of why some countries flourish, while others fall behind.

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Thursday, 21 June 2012

New Supply in the Potash Industry - The First Greenfield Mine In Four Decades

As discussed earlier, the most significant threat to incumbent potash producers is the potential of major new supplies of potash coming online, which would put downward pressure on both prices and profits.  However, the barriers to entry are very high: a capital cost of $4-5.5 billion, and many years before a greenfield mine reaches full production.
This week, German-based K+S AG broke ground on the first new potash mine in more than four decades (there have been expansions of existing mines, however).  The company, as a long-time producer of potash, has credibility that some other would-be producers lack.  For instance, K+S projects that it will take more than a decade to reach full production of 2.86 million tonnes/year, a much more realistic timeframe than is often cited.
However, the company announced a rather optimistic 2015 as their target date to begin producing at 1 million tonnes/year, and a capital expenditure of just $3.25 billion, significantly lower than most other estimates of the cost of bringing on new production.  Time may show that both of these estimates are too low.
The company also suggested that once in production, it's unlikely to sell its potash through the Canpotex marketing body, citing European anti-trust issues.  However, it reiterated its long-held philosophy of maximizing price, rather than the volume of tonnes sold, even if it requires restricting supply.
Overall, this new development should not cause investors in Potash Corp, Mosaic and Agrium to tremble.  The new capacity will be a long time coming.  And it's moderate in size, especially in the early years, which shouldn't cause significant pricing pressure.  Moreover, any pricing weakness will be counteracted by withholding supply.  However, the added production figures to be sizable enough to increase risks for other aspiring newcomers.  BHP's large Jansen project remains the wild card in the potash industry, but recent signs suggest the company will at least postpone a decision on the project.  If K+S's move was enough to give BHP pause, this week's announcement may actually turn out to be positive news for potash investors.

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An Analysis of The State of the Nation's Housing Report

The Harvard Joint Center for Housing Studies, one of the most authoritative sources of information on the US housing market, recently released its annual The State of the Nation's Housing report for 2012.  The fact-filled report provides a comprehensive overview of America's housing market, including the dynamics of supply, demand and price; suggestions on how to improve housing affordability; commentary on the effectiveness of government housing programs; and detailed tables of current and historical information

Overall, the report is cautiously optimistic that the worst has passed in the housing market, and that housing is likely to make a small but positive contribution to GDP growth in 2012, and improve further over time.  This is a matter of concern not only to homeowners, but firms, workers, investors, and governments, as the housing market is large enough to have a major effect on the overall economy.
However, there continues to be a "chicken-and-egg" conundrum: the housing market won't improve until more jobs are created, but job creation depends on an economic recovery that won't fully take-off until the housing market improves.  Over 1.4 million jobs directly tied to housing have been lost, and many more have been lost as an indirect consequence.  In addition, the "wealth effect," the tendency of people to spend more as their assets grow and less as they shrink, has reduced spending, since housing-based wealth has fallen by over $8 trillion.
Below are some key takeaways from the report, organized under the intimately related headings of supply, demand and price.
·        The inventories of new and used houses for sales stand at around 6.0 months of supply, which is considered a balanced market.  However, there is an "off-market" inventory of 1.2 million unsold homes, which could further force prices down when it comes onto market.  For now, though, prices appear to have stabilized at a level at or below where they were before the boom.
·        Single family starts were up 16.6% in the first quarter year-over-year.
·        Thanks to record low interest rates and modestly priced real estate, mortgage payments are now more affordable than rent in most areas - indeed, housing is as affordable as it has ever been.  As recently as 2006, the monthly cost of a mortgage was nearly 50% more expensive than rent payments.  However, strict lending rules have sapped some demand for financing.
·        Due to a sluggish employment market, household formation fell far below trend in the last few years, but pent-up demand will inevitably be released as jobs become more plentiful.  Net immigration, though, fell in the past few years, largely because of increases in emigrants leaving the US and a rise in the number of deportations.  It's unclear if immigration will bounce back to past levels, but in all likelihood the US will continue to absorb large numbers of newcomers in future years.
·       Average household growth of 1.18 million from 2010-2020 is predicted, using quite conservative assumptions, and not including any pent-up demand, which is likely significant.
·       Sales of distressed properties are depressing prices.  Homeowners are very reluctant to sell, however, if they are underwater on their mortgages - "underwater" means the value of the house is worth less than the amount of the related mortgage - which also reduces home renovation outlays, the bulk of which occur soon after someone buys a new house.  This is a problem, since more than one in every five mortgages are underwater - 11.1 million, according to one estimate.  Renovations, though, figure to improve throughout 2012, as investors gobble up properties to rent, and lender prepare foreclosures for sale.   The US home improvement market is a $100 billion-plus market, and any sharp improvement will have an impact on the economy overall.

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Friday, 15 June 2012

Potash Corporation of Saskatchewan - Investment Analysis

Potash Corp is one of the world's leading producers of fertilizer.  Sales of potash account for 64% of gross margins, with the remainder split between phosphate and nitrogen-based fertilizers (since the company's future rests largely on its potash operations, this analysis will focus there).  Five of the company's six potash mines are located in Saskatchewan, the sixth in New Brunswick.  Potash Corp directly supplies the North American market, and sells into the offshore market via Canpotex, a marketing arm operated jointly with Mosaic and Agrium.
Every year, the world's population grows by around 75 million people, relentlessly increasing food demand.  Indeed, now over 7 billion, global population is expected to reach 9 billion by 2050.  Equally important, as poor people in the developing world grow richer – from, say, $1000 US/year in annual income to $2000 – a large proportion of incremental income is used to purchase more nutritious food, namely protein-filled meat.  However, between two and seven pounds of feed (depending on the animal) are required to produce one pound of meat, putting major pressure on the world's crops.
However, little arable land remains available for development.  To produce more yields per acre, therefore, increased fertilizer use is inescapable.  In fact, despite genetic modifications to crops, more efficient irrigation, and other productivity enhancing measures, fertilizer is responsible for about half the world's crop yield.  For most of the past decade, humanity has consumed more food than has been produced, with the difference being drawn from stockpiles.  This will ensure high prices for most crops for years to come, giving farmers an incentive to invest more in fertilizer.  Since the 1960s, potash demand has grown on average by 3% per year, an upward trend likely to continue indefinitely.
However voracious the demand for a product, if new supply is very easy to produce, prices - and profits - will remain low.  Happily, Potash Corp occupies a supply-side "sweet spot": it owns many years worth of reserves, allowing for not just steady but growing production; however, there isn't an over-abundance of supply in the industry overall, which would hold down prices.
Company Reserves
One major challenge that most mining companies face is the "hole-in-the-ground" conundrum: each ounce, pound or tonne sold puts them one unit closer to being out of business.  Potash Corp, however, has 100 years of reserves just at existing shafts, and several centuries' worth of additional supply available, so even investors named Methuselah needn't worry about exhausting reserves.
Barriers to Entry
Building a new potash mine – or expanding an existing one – is a very difficult technical challenge, and even if all hurdles can be cleared, the economics are imposing: a two million tonne/year greenfield (new) potash mine in Saskatchewan costs between $4.0-5.5 billion (including infrastructure), and takes at least seven years to produce at full capacity.  Few investors are interested in an investment of such size when the payback period is so far in the future.  After all, a lot can happen over a seven year period (or longer), including rising costs, falling fertilizer prices, royalty changes, credit crunches, and many other unwelcome developments. 
According to Potash Corp, a netback of at least $600 is required to justify such an endeavor, even assuming a very affordable expansion and settling for a very average 10% internal rate of return.  More expensive investments, and a more ambitious 15% return would demand a netback at or above $1000 per tonne.  Currently, netbacks are under $500 per tonne.  These formidable barriers to entry serve to insulate existing producers from new competition, however. 
Eventually, high prices will ensure new greenfield supply, which will push down prices, and make the industry less attractive.  However, new supply can't sneak up and surprise the industry, and it's virtually assured that potash sales will provide investors with attractive returns for many years.  In fact, past projections of future supply have turned out to be much higher than what was actually achieved.
Two added factors make Potash Corp's supply situation yet more attractive:
OPEC-like Economics
Potash Corp is one of three North American producers that sell into the offshore market via Canpotex, which operates a shared infrastructure, reducing costs.  But the marketing body's most important function is to restrict supply when demand is soft, thus propping up prices, similar to how OPEC operates in the global oil markets.  A similar arrangement between several large Russian and Belarusian producers operates in Europe, and the two marketers combined supply over 60% of the world's potash.
Low Cost Producer
Potash Corp is among the world's lowest cost producers.  In a commodity industry, the surest, and often only, way to gain a competitive advantage is to be the low-cost provider.  Just as drivers don't care whether they fill their tanks with Shell's gas or Exxon's, farmers aren't loyal to one supplier's potash over another's; the only thing that will attract a farmer's hard-earned dollars is a more affordable price.  Though Potash Corp is willing to accept reduced volumes in return for higher prices, if it was unable to do so, it could remain profitable even at lower prices.  In fact, it has done exactly that: due to the recession, the company operated at a mere 30% of capacity in 2009, but nonetheless logged the third best results in its history to that point, in part due to its low-cost economics.
Potash Corp has a first-rate management team.  CEO Bill Doyle is competent, honest, an independent thinker, and a patient, long-term planner.  There’s a solid bench of talent behind him, which isn't always the case among senior management in the mining industry.  The company manages its operations reliably and safely, and maintains good relations with its largely unionized workforce.  In addition, it has an unusually transparent board, and superb relations with investors.  One could argue, however, that the board has lavished the CEO with compensation beyond what's necessary to motivate and retain him, though the stock has performed exceptionally well during his reign.
Shareholders will only enjoy excellent returns if earnings are reinvested wisely.  Over the past decade, Potash Corp's management has done an excellent job allocating capital.  The company has reinvested much of its income internally – it'll amount to nearly $8 billion by the time expansions are complete – at high returns on capital: from 2004-11, ROE ranged from 13%-76%, and averaged 29%.  $6.3 billion has been spent repurchasing shares during that period, shrinking the share base by more than 20%.  Most importantly, buybacks have been pursued only when shares were cheap or reasonably priced.  $2 billion was spent over the same time frame on equity investments, which have ranged in price from between $8-10 billion in recent years.  Finally, the company pays a modest, but quickly growing, dividend.  Shareholders can rest assured that management will use earnings to add value in the future.
Given the company's cost structure and the complex formula that determines its mining taxes, it's difficult to project Potash Corp's future earnings.  Helpfully, the company has published broad guidelines for its earnings potential over the next few years.  The most aggressive scenario they contemplate is actually quite realistic, and would see the company earning around $6.0 billion by 2015 or 2016.  However, free cash flow would be approaching $6.4 billion, as the company's ongoing capex will have fallen significantly below its depreciation and amortization expense.  Assuming a multiple of 15 times FCF, Potash Corp's market cap would be $96 billion.  Assuming earnings of $23.7 between 2012 and 2016, D & A of $4.2, and capex of $5.5 billion, cumulative FCF through 2016 would amount to $22.4 billion.  Assuming the company's common stock investments appreciate by 50%, to around $12 billion, and subtracting current net debt of around $4.3 billion, the total return for shareholders could plausibly amount to about $126 billion, or $148 per share.  Even if shareholders assumed a more cautious total return of $125, from the current $40 or so price, the return would be well over 25% per year through 2016.
Any mining project carries with it significant technical risks.  However, Potash Corp operates six mines, and a problem at any specific mine - water inflow, challenges with expansions etc. - won't affect production elsewhere.  The company has decades of experience, and formidable resources, so any problems that arise are likely to be dealt with effectively.
The company's most serious risk is the threat of substantial new supply pushing down prices.  Though the barriers to entry into the potash market are high, they're not infinite, and at some point high potash prices will prompt new supply.  There have been long stretches in the past when profitability in the industry has been ruined by excess supply, and it could happen again in the future. 
While there are over 50 potential potash projects worldwide, only a handful of those stand much chance of being developed.   The most talked-about potential new entrant into the potash industry is BHP Billiton, which may develop its large Jansen project.  However, the company has yet to decide when – or even whether – to go ahead with its project, and recent reports suggest the company may postpone a decision for up to two years.  Overall, it seems unlikely that there will be any new greenfield supply in the industry for a decade or so.
Potash Corp is a superb company.  It has a valuable economic and strategic resource.  For all the uncertainty that investors face - economic, political, technological - peoples' appetites won't disappear any time soon.  Increasing demand for food, combined with an enviable supply-side equation for the company, means Potash Corp stands to reap huge and growing profits, and high returns on capital, for at least a decade to come.  An experienced, high-quality management team will navigate the company through any challenges, and will continue to create shareholder value.
2011 AR, 2012 Q1, a Globe and Mail article on BHP Billiton, and several recent company presentations and transcripts:

There's ongoing commentary on Potash Corp: an update on the first greenfield mine in the potash industry for over four decades; a 2012 second quarter update; a 2012 third quarter update

Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.

Monday, 11 June 2012

Economic Fairness Further Explained

In an earlier article, I explained why deflating to competitiveness through falling wages is unlikely to work in Greece - or Spain or Italy, for that matter.  The reason for the stubborn "stickiness" of wages has been long understood: workers are reluctant to accept significant wage cuts out of a sense of fairness.

In a recent article entitled, "The Fairness Trap," James Surowiecki, a regular financial columnist for The New Yorker, further explores the concept of fairness in economics, and shows how it's undermining an effective response to the current European crisis.  Not only are beleaguered Greek workers railing against further cuts, German voters have grown tired of contributing financial aid for a crisis they didn't cause.  

Suroweicki touches on experimental work which shows that people sometimes prefer to receive no money at all than to accept an unfair deal, if rejecting the deal also punishes somebody who's perceived to be acting unfairly.  This is contrary to rational expectations theory, a bedrock assumption of economics.  Further reinforcing deeply felt convictions of fairness is "self-serving bias," a self-explanatory phenomenon that reinforces perceptions of fairness.  Predictably, people often believe that what's best for them is also what's fairest in general, making such beliefs difficult to shake.

This is not just some interesting fact from economics, however: if somebody doesn't bend, he argues, the Euro might collapse.

Friday, 8 June 2012

ATP Oil and Gas - The New CEO Resigns

Many frustrated shareholders of ATP Oil and Gas believe that poor management is to blame for the company’s sub-par performance, and were relieved and heartened last week when the company announced the arrival of a new CEO.  The feeling was short-lived.  Yesterday, ATP announced that the new CEO, Matt McCarroll, has left the company because the two sides were unable to agree on an employment contract.  ATP’s stock fell by 9% Friday, and Bloomberg reported that the company’s May 2015 bonds fell to 45.75 cents on the dollar to yield nearly 50% in intra-day trading.
It’s unclear what the company’s next move will be.  Presumably Chairman Paul Bulmahn will return to the CEO role, at least in an interim position.  The company may have made the initial change because of a lack of faith in Bulmahn, or out of a sense that McCarroll was such a rare and special talent that ATP was willing to adapt itself around him.  If it’s the former, then the company will likely begin a search for a permanent CEO immediately; in the latter case, it’s possible that ATP will stick with Bulmahn indefinitely.  The latter seems more likely, given the abrupt nature of Bulmahn's resignation, and that it coincided with McCarroll becoming available after selling his company. 
Often, a company's number two officer is a leading candidate for the CEO position when the incumbent moves on.  Based on recent developments, however, it seems safe to assume that President Leland Tate is not in the running to be the next CEO.

At minimum, this episode makes ATP management look unprofessional.  In addition, a pending change at the top is a distraction.  After all, management's time, attention and energy are among any company's most precious resources.  Without more detail, though, it’s difficult to draw many firm conclusions, but anxious shareholders will be in a state of uncertainty for the immediate future.

(My original write-up on ATP Oil and Gas can be found here).
Disclosure: The author was long ATP options at the time this article was published.
Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.

Leucadia National and the Commodities Supercycle

The recent world economic slowdown has included the developing world, which largely escaped the severe 2008-09 recession.  The prominent BRIC nations, too, have showed surprising weakness, with India reporting disappointing growth figures, Brazil already cutting rates, and Russia sure to slow if the price of oil continues to fall.  But the "C" is more important than the "BRI": not only is China larger than all three countries put together, it's growing faster.  However, even the Chinese juggernaut has begun to slow.  First quarter GDP fell to 8.1%, which is still robust, particularly given the Middle Kingdom's $7 trillion-plus economy.  However, second quarter growth may be still lower, which was likely what prompted the government's recent decision to cut interest rates.
Given the short-term mindset that prevails among financial commentators and investors alike, the end of the commodities "super-cycle" is already being declared.  Perhaps it will indeed slow; only time will tell.  But two of the finest investors of the past few decades don't appear to believe the newfound hype.  Ian Cumming and Joseph Steinberg, the superb two-man team at the helm of Leucadia, state their case on commodities simply in their 2011 annual report: "We continue to believe that as citizens of historically poor countries get richer they will demand higher quality items – and more of them" (1).  Accordingly, they have most of the firm's capital invested in companies that stand to prosper only if commodities remain priced at relatively high levels.
They hold a large position in Inmet Mining, a Canadian firm whose production is centered on copper, along with a few other minerals.  While Leucadia has sharply reduced its common stock position in Fortescue, a miner of iron-ore, it holds a significant royalty interest in the Australian company's production.  Most significantly, Leucadia recently closed its largest ever acquisition by purchasing National Beef Packing, paying $868 million for 79% of the company (2).  Though the company is based in the US, a mature market for beef, the global trade in meat is growing significantly, a market the company will tap into.  As poor people in developing countries grow wealthier, one of the first changes in consumption is a move to add more protein to their diet, mostly by eating more meat.  Only if this trend continues is National Beef Packing likely to grow.
Cumming and Steinberg increased Leucadia's book value 18.5% per year from 1979-2011, despite a large one-time dividend in 1999 that significantly reduced shareholders equity (3).  Over that three-decade-plus time span, these super-investors saw many trends come and go, but they remain confident that the rise of the developing world is a secular change, and the commodity boom that began more than a decade ago will likely continue.  They could be wrong, but bet against them at your own risk.

Sources (1), (2), (3): Leucadia 2011 AR
Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.

Thursday, 7 June 2012

Book Review - Warren Buffett and the Art of Stock Arbitrage, by Mary Buffett and David Clark

Warren Buffett is widely known for investing in high-quality businesses with a sustainable competitive advantage, a high return on capital, run by able and honest managers, and selling at a bargain price.  When he's able to find such gems, he likes to hold them long-term, ideally "forever."  His success in arbitrage and special situations investments, however, is not widely understood.  In fact, these investments are in some ways the very opposite of his usual focus, as they offer only a one-time, short-term opportunity.  A study of Buffett's investments from 1980 to 2003 found that the average investment returned 39% per year, but the average arbitrage deal returned an incredible 81%.  Without such investments, his overall performance would have fallen significantly, from 39% to 27%.  In Warren Buffett and the Art of Stock Arbitrage, Mary Buffett and David Clark set out Buffett's criteria for making such investments.
Buffett has focused on three forms of arbitrage - friendly mergers, hostile takeovers, and corporations making tender offers for their own shares - and four kinds of special situations - spinoffs, liquidations, stubs and reorganizations.  Arbitrage is a broad term that refers to an opportunity to capture a spread between two prices, such as gold selling at a higher price in one market than another, even when accounting for currency differences.  But Buffett pursues stock arbitrage, where the price being offered for a security is higher than the price currently prevailing in the market.  If Company A, for example, offers to buy Company B for $100 per share, B's stock may settle around $95.  The $5 spread, which exists because there is always some uncertainty - financing, regulatory, legal etc. - about whether the deal will successfully close, offers arbitrageurs the chance to profit.
Buffett considers arbitrage deals once they've officially been announced, and acts only if he feels there's a high probability that the transaction will be completed.  His analysis boils down to a few variables.  On the upside, he calculates the likelihood the deal will be completed, the percentage return, and the approximate amount of time to completion.  On the downside, having already estimated the likelihood that the deal goes through as planned, the major factor left to figure out is how far the stock will fall if the deal fails.
Returning to the above example, the upside for arbitrageurs in Company B is 5.3% (5/95).  Assuming the deal is certain to close in six months, the annualized (non-compounding) return would be 10.6%.  Since most other investments are quoted in annual returns - on bonds, in the stock market etc. - this return could be compared to other potential investment opportunities, as well as alternative arbitrage deals.  (The calculation becomes somewhat more complex when adjusting for the probability of the deal closing as planned, as set out in the book's fifth chapter).  The basic concept holds for stock-for-stock deals, cash offers, and hybrids.
The math's laughably easy, but estimating the probability that a deal will close can be tricky.  Any deal faces several possible hurdles: legal impediments could nix a proposal, financing could fall through, shareholders could reject the deal, and so on.  Friendly mergers are most likely to close, since shareholders tend to vote in favor of proposals that are endorsed by management and the board.  Of those, Buffett prefers self-financing, strategic buyers that are pursuing a company to complement their existing business - think Procter and Gamble's purchase of Gillette - rather than hedge funds or LBO firms that rely heavily on financing which might dry up unexpectedly in tough markets.  Buffett is wary of deals that might attract serious scrutiny from regulators or anti-trust commissions: not only do prolonged investigations erode the time value of money, they occasionally scuttle a deal altogether.  While not all stars must be perfectly aligned - Buffett has even played hostile takeovers in the past, though rarely - these are the basic parameters that he looks for.
Buffett has also found opportunity in companies changing form, usually from corporations to royalty trusts or master limited partnerships (MLP).  Surprisingly, the market often doesn't immediately recognize the shift with an increased stock price until after the change has been made, even though the transformations are usually almost certain to be implemented.  The authors helpfully offer an example of Buffett's investment in each situation - Tenneco, a natural gas producer, which converted to a trust, and Service Master, a collection of different businesses that became an MLP - and his approximate return.
Additionally, Buffett has invested in spin-offs, where a company that owns multiple businesses breaks into two or more stand-alone firms that figure to be worth more separate than together.  Buffett's interest in spin-offs lies in the chance to acquire excellent businesses that have previously been unavailable to invest in directly.  Buffett takes his position in the parent company before the spin-off occurs, then sells the parent and holds the new stand-alone firm.  This is just what he did, for example, when Dun & Bradstreet spun off Moody's in the late 1990s.  This chapter is thin on analysis, and leaves important questions unanswered: for example, why doesn't Buffett wait until after the spin-off has concluded to purchase the preferred company, as Joel Greenblatt has done with great success? 
Given that Buffett is the greatest investor in history, any serious book about his methods is worthwhile.  However, nagging questions sometimes remain about just how accurate Buffett commentators are.  For example, on the all-important matter of how he values a business (not a concern in this particular book, granted) Buffett and Clark offer one explanation (found in Buffettology), Robert Hagstrom another (basically a standard discounted cash flow model) and Alice Schroeder still another (according to her, he requires a 15% return, and makes a "yes-or-no" decision accordingly).  All are leading authors on Buffett, yet offer differing accounts on a basic and important aspect of his approach, leaving students of investing puzzled. 
Despite the authors' past work on Buffett and their personal ties to him - Mary Buffett was married to Buffett's younger son, David Clark has been a long-time Berkshire Hathaway shareholder and student of Buffett, and they refer to him in the book familiarly as "Warren" - this book prompts a few similar doubts in places.  There's little sign that Buffett participated in this book's creation, made factual corrections or personally endorsed it.  There are other clues that the authors reach conclusions based on deduction, rather than first-hand conversations with Buffett.  For example, when discussing his 1998 investment in a liquidating REIT, they state, "Warren would have had five thoughts..." (104). There’s ample reason to suspect that their after-the-fact re-creations are largely right, but Buffett's thinking may have been different from what the authors imagine.  It would have been helpful if they'd been more forthcoming about the evidence they used to arrive at their conclusions, ideally in the form of footnotes.  Though there are no obvious errors, parts of the book seem slightly vague.
Still, Mary Buffett and David Clark have written yet another first-rate book on Buffett, and have illuminated one of the few remaining areas of Buffett's career that hasn't been widely studied.  In just over 140 short pages, they cover a range of non-standard investments that Buffett has made, while offering enough detail for investors to begin pursuing similar opportunities.  Though picky readers may have some small doubts about Buffett's precise methods, the authors discuss each topic clearly and knowledgably.  Besides, Clark runs a partnership that pursues special situation investments, so he brings insight of his own to any areas where Buffett's approach may not be entirely clear.  To complement the theory that fills most of the book's pages, they offer practical advice about how to search for ideas, what relevant filings to study, and how events such as tender offers play out in reality.  Overall, Arbitrage lives up to the high standards that Buffett and Clark have set for themselves in their past work.

Buffett, Mary and Clark, David. Warren Buffett and the Art of Stock Arbitrage: Proven Strategies for Arbitrage and Other Special Investment Situations.  New York: Scribner, 2010.
Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.