Profile - Tim McElvaine

In the 11-year period from 1997 to 2007, Victoria, B.C.-based investor Tim McElvaine returned 21% per year before fees (16% net to investors), compared to 11% for the S&P/TSX index.  Moreover, he didn't suffer a single down year, while the index fell three times.  This impressive result was achieved despite holding large amounts of cash: in fact, on average he was only 82% invested over the period.  In theory, had he been fully invested, McElvaine's gross returns would have exceeded 25% per annum.

But - and with a cutoff year of 2007 you knew there was a "But" coming - in 2008 his fund fell by almost half.  McElvaine was hardly alone in this, of course; unlike many investors, however, he has yet to rebound sharply since the end of the Great Recession.  Indeed, even after a net return in 2012 of 18.3%, McElvaine remains about 30% off his former peak.  In absolute dollars, his fund has shrunk even more dramatically, forcing him to lay off most of his already small group of staff.  Will Tim McElvaine return to his past stellar performance, or was he permanently diminished by the recent turmoil?

An 11-year run of substantial outperformance is likely long enough to rule out pure fluke.  However, in order to determine with confidence if his pre-2008 success was a streak of long-lasting good luck, or the product of skill and experience, it's necessary to look beyond just the numbers and assess the "How" and "Why" of his performance.  

McElvaine's philosophical influences include John Templeton, Ben Graham and Warren Buffett.  Peter Cundill, though, was not only an intellectual influence, he hired the young and persistent McElvaine, and mentored him first-hand.  One of the qualities that Cundill instilled in McElvaine was patience.  This helps explain why McElvaine has steadfastly - and correctly, in this writer's opinion - held on to Glacier Media.  For many years Glacier has been his largest position, but the stock has underperformed lately, and is partly responsible for his restrained post-2008 performance (in fairness, he originally paid around $0.70 for GVC, so the fact that it hasn't done anything for him lately doesn't mean it hasn't done anything for him at all).  In addition, Cundill's interest in Japan wore off on McElvaine.  Most notable North American investors must think the fallen country's nickname is Land of the Setting Sun, if they think of it at all, but McElvaine had 17% of his portfolio committed to Japan at the end of 2011.

In the manner of Graham and Buffett, McElvaine has a disciplined, multi-faceted approach to estimating a company's value, and is sure to only buy at a discount, leaving him a "margin of safety."  His own personal twist is that he likes to buy when sellers are so determined to unload their position that they "don't care about price" (p.36).  Arguably, buyers of Glacier Media have been purchasing from sellers that blindly lump the company together with the newspaper industry in general, without regard for its genuine differences.  Other cases where sellers want out regardless of price may include a stock that has been delisted from an index or distressed securities that funds are not permitted to hold.

In addition to the margin of safety, McElvaine's investing approach is similar to Buffett's in several ways: like the Oracle of Omaha, McElvaine runs a concentrated portfolio, where single positions can constitute 10% or more of his portfolio; when a stock falls, he tends to add to his position, on the reasoning that the upside is higher and the margin of safety larger; when he assesses management and directors, he ensures that they behave in the shareholders' interest, not their own, and occasionally takes a seat on the board to make sure executives don't confuse the two; and he focuses on return on capital and cash flow.

Some of McElvaine's habits and values resemble Buffett's, as well.  In describing a typical day at the office, he cites a poster that reads, "Sometimes I sit and think, and sometimes I just sit," which would delight Buffett, who firmly believes that activity is the enemy of investors.  McElvaine, like the Berkshire Hathaway CEO, has the bulk of his family's money invested in his fund, as they both like to "eat their own cooking."  And McElvaine's letters to partners, while not appointment reading for most of the investing world, are unfailingly candid and humorous.

One important area where McElvaine strays from Buffett, however, is in his willingness to own "duds" (p.45).  As he explains, "What I ideally like is a mediocre business, so to speak, that each year will be worth a little bit more primarily because of cash flow" (p.47).  Buffett, on the other hand, refuses to invest in companies without a sustainable competitive advantage.

There's a good chance that McElvaine will return to form in the future.  His success in the past was not an accident, and he has wisely remained loyal to the key ideas that have served him, and many other excellent investors, so well.  To be sure, he has tweaked a few things, such as investing less money in small caps to provide more liquidity, and diversifying into a somewhat larger number of holdings.  To his credit, however, he hasn't abandoned a formula that is likely to work over time.  And a greater commitment to buying only companies with a wide and formidable "moat" would further increase the odds that Tim McElvaine returns to his past glory.

Sources: Thompson, Bob.  Stock Market Superstars: Secrets of Canada'sTop Stock Pickers. Toronto: Insomniac Press, 2008.

Publications that can be found on Tim McElvaine's website. 

Other Profiles include investor Tom Stanley, and New Yorker writer James Surowieki.

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.

On The Economist's Special Report on Reshoring

The Special Report in the January 19, 2013 issue of the Economist, focuses on the increasing trend of "reshoring," bringing back manufacturing and some services jobs that were once "offshored" to foreign countries.  There are several reasons for this. 

Costs

Wages in China and India have been rising 10-20% a year for decades, and, while still much cheaper than developed world rates, are doubling as quickly as every five years.  When the cost of overseas shipping is included, the difference between developed and developing world costs narrows further.  Though rarely noted in the media, more jobs are lost due to automation than from offshoring, and labor's component of overall costs has continued to fall.  Manpower urges companies not to offshore at all if labor consists of 15% or less of a product's overall cost.

Risk

Shipping often takes weeks, and global supply chains expose companies to political, currency, climate, intellectual property and many other risks.  Boeing, for example, suffered badly by outsourcing too much of its supply chain, and Samsung used the knowledge it gained manufacturing for clients and became a competitor, and a triumphant one.

Customers

Much of the motivation is simply to be close to end markets, where it's easier to respond quickly to the tastes and demands of local customers.  In addition, offshoring enrages many citizens who are also potential customers, and reshoring can make for good public relations. 

Innovation

Interestingly, one justification for bringing production "home" is to increase innovation by having manufacturing and research and development (and, though the Economist failed to emphasize it, design, data analytics, marketing and customer service) housed in the same location, a move towards the "end-to-end" production that Steve Jobs advocated.  (Ironically, Apple has outsourced much of its manufacturing to Foxconn, with a number of high-profile consequences).  It's more difficult, on second thought, to draw a distinction between "core" functions, and superfluous ones.

Herd Behavior

And, to the Economist's credit, it points out that some of the frenzy for offshoring was caused by "herd" behavior in the first place. Very simply: some companies did it merely because other companies were doing it.  One quality that Warren Buffett looks for in managers is independence, to avoid lemming-like behavior.

Conclusion

In the end, reshoring likely won't happen in revolutionary numbers, but gains in manufacturing may offset most of the losses in services, and a significant drag on developed-world workers will be lifted.

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.

The Trouble with Mining - Management or Structural Issues?

Rio Tinto boss Tom Albanese recently became the latest CEO of a major mining firm to be relieved of his duties.  His departure came in response to a $14 billion write-down that resulted from the 2007 purchase of Alcan, then a leading aluminum company.  He joined a growing list of departures that includes the top executives of Anglo American, Vale, Barrick Gold and Kinross Gold.  

Before 2008, the rising tide of the commodities "supercycle," propelled by infrastructure-heavy economic growth from the developing world, was enough to lift the earnings and share prices of many resource producers.  But as Warren Buffett has warned, when the tide goes out, you find out who's been swimming naked.  Today's unforgiving daylight reveals repeated cost overruns, rampant technical setbacks, and a pattern of overpaying for acquisitions.  Investors are left to wonder whether this is a management problem, which is solvable, or a more structural situation, which may not be?

Part of the blame lies squarely on management.  It's well known that around two-thirds of acquisitions fail, largely because acquirers routinely overpay.  The burden of proof, then, falls on senior executives and board members to demonstrate that their own prospective purchases are an exception to the general trend.  Even without the easy judgments of hindsight, the Alcan deal was always risky, given that aluminum is abundant and thus never in short supply.  Managers in the mining industry tend to be particularly poor at allocating capital: not only do they overpay for assets, they often have a soft addiction to issuing new equity, whatever the price; they rarely pay dividends; and they almost never take advantage of weak share prices to repurchase shares. Out-of-control costs and technical failures reflect mismanagement, as well.  Too often, managers have failed to halt development, even when added expenses push the rate of return to dismal levels, and executives have been unable to deliver on production or schedule-related promises.  

Still, many of the problems in the resource extraction industry are structural.  It is telling, in fact, that the names appearing on the casualty list above are managers from the strongest mining firms in the world.  As such, they have built-in advantages over competitors, including the resources to attract the best managers in the industry - in theory, at least - assets that are diversified both by geography and by mineral, and a lower cost of capital.  

Nonetheless there's a long and daunting list of enduring challenges in the mining industry: the difficulty of operating many mines reliably and profitably; unsteady demand; a lack of skilled technical labor, and shortages of general labor; ore grades in permanent decline; and a litany of political, regulatory, legal and environmental obstacles.  As if all that weren't enough, the largest problem is the "hole-in-the-ground" conundrum: every ounce, pound or tonne a producer sells leaves it one unit closer to being out of business.  These challenges surely contributed to many the mistakes and failures noted above.

This doesn't mean that there are no attractive mining investments.  The surest way to get an edge in a commodity business is to be a low-cost producer.  Most importantly, this means owning low-cost mines with long lives, as BHP Billiton does, for example.  As noted, size typically ensures large companies access to cheap capital, as well as a strong balance sheet that can withstand volatile commodity prices.  In addition, vast resources typically allow companies to better navigate the political, regulatory, legal and environmental challenges that exist in the global resource industry.  And a world-class management team is not only desirable, but flat-out necessary.

Potash Corp may be one of the few mining companies that’s worth investing in, despite the general difficulties of the industry.

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Calculated Risk

Investors searching for topical coverage of macroeconomic news ought to visit Calculated Risk, hosted by Bill McBride, a retired executive.  Fact-based and analytical, the blog covers most major economic data, with a focus on the US market.  Posts are timely, usually following official releases within a couple hours, often quicker.  The value-added comes in the form of placing data in its historical context, with the aid of simple long-term graphs.  In addition, many indicators are compared to other current data.  Though thorough, the posts are concise.

The blog pays careful attention to the US housing market, which closely correlates to the overall health of the American - and global - economy.  In fact, Calculated Risk was one of the few voices of alarm during the nearly decade-long housing bubble.  The crash may not have been so severe if more people had paid attention to historical rates of housing starts and household formation: for several years, housing starts were sharply higher than houses formed, and it should have been clear that eventually the hangover would match the party.  Although the blog covers other housing-related data, by highlighting those two simple numbers Calculated Risk was offering the public a great service, even if it went ignored.

Most of us were surprised by the intensity of the recent financial crisis; when the next one inevitably arrives, regular readers of Calculated Risk may not be caught entirely off-guard.


Another excellent resource on macroeconomics is the Rail Time Indicators report.

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.

Book Review - Steve Jobs, by Walter Isaacson

Mere mortals dream of changing the world; Steve Jobs, however, hoped to "make a dent in the universe."  Partly because of an ambition that knew no earthly bounds, Jobs became one of the towering giants of the twentieth century and beyond - the focus of business case studies, tech newsletters, industry forums, and innumerable other venues.  It's telling that Walter Isaacson, the author of well-regarded biographies of Albert Einstein and Benjamin Franklin, considered Jobs a worthwhile subject.

By borrowing - or stealing - the concept of the graphical user interface from Xerox, then greatly improving on it, Jobs helped bring useful and intuitive computers to the masses.  Later the iPod changed how music is stored and consumed.  Apple sold an astounding 90 million iPhones - also known as "the Jesus phone" - over the first three and a half years of existence, collecting about half of all the profits for the global mobile phone industry.  The company later sold a mind-boggling 15 million iPads in the nine months after its release, among the most successful product launches in history.  Thanks to all these interwoven successes, Apple has recently become the most valuable company by market capitalization in history, and has had a social and cultural influence to match its financial glory.  

Not only did he play a central role in revolutionizing the computer industry, Jobs also upended a range of other businesses.  After he took command of Pixar, then fast approaching bankruptcy, it quickly became the gold standard in animation, creating hit after amazing hit, both critically and commercially.  Pixar was so spectacularly successful that even the vaunted Disney, long the standard bearer in animated movies, could no longer match the upstart studio, and bought it for the princely sum of $7.4 billion.  Moreover, Isaacson notes, the transaction had the feel of a reverse takeover, with the creative team at Pixar taking control of Disney's legendary animation studio.

More recently, he helped bring change to several sectors of the publishing industry.  The sheer reach of the iPhone and iPad together made the "app" business model viable.  Somewhat walled off from the worldwide web, applications have changed many business models in an online world, allowing magazine publishers, for example, to charge money for an exclusive readerly experience, and giving book publishers a further outlet for their literary wares.  In addition, Jobs  entered the old and difficult retail industry and achieved wild success.  By employing his famous eye for detail - only stone from a specific quarry near Florence, Italy is good enough for Apple stores, Jobs decreed - he created Apple stores, which broke a record for fastest march to $1 billion in sales, including Manhattan’s Fifth Avenue store, which grosses more than any other location in the world.

The Apple co-founder's unparalleled accomplishments came despite his many glaring defects.  Jobs, nearly everyone agrees, was petty, needlessly cruel, unreasonable, disloyal, unpredictable, and often flat-out weird.  Indeed, he often cried, and for long stretches of time, rarely bathed.  Name a character flaw, and Jobs probably suffered from it - and the people around him suffered because of it.  Yet even in the course of a foreshortened life, he achieved just what he set out to do.

How was he able to do it?  This riddle is of interest not only to entrepreneurs, business and civic leaders, but to investors, too.  Some of his success, as always, had to do with luck.  For example, it’s not an accident that many tech firms were founded in Silicon Valley in the postwar decades, and Isaacson does an able job evoking the milieu in which Jobs came of age.  And he had enviable personal qualities to go along with the less desirable ones, including charm, a dramatic showman's streak that helped with the public aspect of his job, and a "reality distortion field" that helped him realize the seemingly impossible, even as it led to many mistakes and miscalculations.  However, as Isaacson illustrates in generous detail, the answer lies largely in that Jobs embraced the same kind of multi-disciplinary mode of thinking that super investor Charlie Munger advocates.  

Much of Jobs' success derived from his natural curiosity and wide-ranging self-education.  Indeed, when he grew tired of a standard, "by-the-book" degree at Reed College, he dropped out, but remained on campus and audited classes that interested him.  These included calligraphy, which he later credited for the "multiple typefaces" and "proportionally spaced fonts" featured on the Mac.  The "Less is More" Bauhaus movement informed the design of Apple products Isaacson and a number of Jobs' friends believe that Jobs became the embodiment of the convergence of hippie counter-culture and high technology.  His many other influences included a lifelong interest in Eastern spirituality, including Zen Buddhism and meditation; organic gardening; listening to, studying and playing music; reading literature and contemplating and writing poetry.

Isaacson argues convincingly that Jobs was a "magician genius," whose world-changing flashes of insight came more from intuition than from a rational mode of thinking.  As a young man, Jobs embarked on a pilgrimage to India, where he learned to value intuition as much as abstract and rational thought.  Unlike most analytical executives, Jobs paid no attention to market research, preferring instead to intuit what customers want, often even before they knew they wanted it. 

Thanks to his broad influences, Jobs was able to wear many hats at Apple.  He knew enough about engineering and electronics to understand the hardware, and had a sufficient grasp of programming to stay abreast of the software.  Jobs had a rare and special talent for marketing and branding.  Indeed, he personally oversaw all significant aspects of Apple's marketing efforts, getting involved in the nuts-and-bolts of billboards, magazine spreads, televisions commercials, and all other communications, almost unheard of for a CEO.  And he was particularly good at aesthetics and design, devoting much of his time and energy to ensuring a beautiful and elegant physical structure for all of Apple's products.  

It's possible that Jobs reached too liberally for ideas.  He went on strange diets, and insisted, all olfactory evidence to the contrary, that eating only fruits and vegetables meant it wasn't necessary to wear deodorant or bathe.  He christened one version of Apple computers the "Lisa," after his daughter.  And it’s debatable whether the use of recreational drugs and Freudian analysis are helpful in business or otherwise.  Perhaps fatally, when he was diagnosed with cancer, Jobs embraced a variety of unorthodox ideas, including unproven remedies found on the internet and consulting a psychic, and refused to undergo standard treatments for nine long months.  However, his famed "reality distortion field" bears much responsibility, too.  And, in fairness, it's impossible to be sure that a more orthodox medical approach would have vanquished his cancer.

Still, the magic he made came at the intersection of technology and the liberal arts.  If Apple and Pixar stay true to this ethos, they may well endure for many years to come.  When it was time for Pixar to move into a new building, Jobs designed it personally, ensuring that the central atrium would encourage inter-disciplinary collaboration from members of different departments.  He died before he was able to implement it, but Jobs spent many hours in the last years of his life attempting to do the same for Apple future headquarters.  He once explained the Xerox episode by proudly quoting Picasso: "Good artists copy, great artists steal" (98).  By applying a range of ideas from different disciplines, whether borrowed, copied or stolen, Jobs did more than create a masterpiece, he made a dent in the universe.

Source: Isaacson, Walter.  Steve Jobs.  New York: Simon & Schuster, 2011.

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A Summary of "Air Conditioning: No Sweat" by the Economist

A fascinating article recently appearing in the Economist discusses the wide-ranging effects of air conditioning on society.  Economically, it has long been known that cooler air leads to sharp increases in productivity.  Indeed, one study showed that workers in the coolest parts of the world are 12 times more productive than their counterparts in the hottest parts of the world.  Despite the fact that relatively few people work in temperatures at either extreme, and despite the fact that air conditioning has spread widely even in poor, hot countries, further penetration into those same, often heavily populated countries, is sure to lead to further increases in productivity and wealth.

Cooled interiors have had an impact in on politics, too.  One academic argues that the ability of retired Americans to migrate to the warm, southern states is part of the reason that the Republicans were able to claim what had long been a Democratic stronghold, and now forms the geographic base of the GOP.

To read about air conditioning's effect on human health, the environment, architectural design and much else, the article can be found here.

 

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.

Potash Industry Update - Mosaic 2013 Q2 Earnings

Mosaic recently reported results for the second quarter of fiscal 2013 - the company will soon move to align its fiscal year with the calendar year - and the conference call featured some interesting comments about the potash industry.

The company remains bullish on the prospects of potash - and fertilizers in general - both in the long-term, and over the course of the next year.  Despite continuing politically-driven and currency-related problems in India, Mosaic expects a record, or near-record year of potash consumption, in part because net farm income is as high as it’s ever been, while fertilizer remains very affordable.  Indeed, the costs of fertilizer are as low as a percentage of crop prices as they've been in 10-15 years.

Mosaic outlined their medium-term assumptions for potash industry, as well.  Demand, management forecasts, will be 55-57 million tonnes for fiscal 2013, 59mmt for 2014, and rise to 63-64mmt for 2017.  Industry capacity, they believe, will be in mid-70mmt range, meaning that the industry will be operating at 85-90% capacity, which should be good for prices.

Significantly, CEO Jim Prokopanko strongly hinted that when the current MOU expires at the end of this year, Canpotex will discontinue its long-standing policy of selling to China and India on contracts, and begin selling instead on the spot market.  He noted that contracts were signed for a year in the past, were reduced to the present six month terms, and - wink, wink - said, "I think you can see the direction we're headed" (1).  This will make for a much smoother quarter-by-quarter business, and will likely also mean somewhat higher prices, but somewhat lower volumes.

Sources: (1) http://seekingalpha.com/article/1095101-the-mosaic-management-discusses-q2-2013-results-earnings-call-transcript

My analysis of Potash Corp is here.

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.

 

 

Canpotex Signs a Potash Contract with China

Canpotex recently agreed to sell 1 million tonnes of potash to China for $400 per tonne, significantly lower than the most recent deal, which set the price at $470.  At first glance, the move appears surprising.  After all, Canpotex maintains a religious policy of curtailing supply in periods of soft demand, which usually prevents prices from falling abruptly.  And the marketing body, which sells on behalf of Potash Corp, Mosaic and Agrium, has cut production significantly in recent months.  What's more, potash consumption in 2012 was as high - or nearly so - as it's ever been.  However, robust end-market use has not translated into mine production on a one-for-one basis over the past year, as many farmers and distributors have drawn down inventories, rather than purchasing additional product.

Though the price is lower, the deal will have some advantages for producers, both in the near-term, and over the long-term.  For one, it gets a significant amount of product moving.  In addition, it may prompt India to re-enter the market, which has been very difficult of late, largely due to domestic political forces.  Given that potash mining has significant fixed costs, there is also some merit in having a decent base load of product being sold.  Finally, it may also tighten up spot markets later in the year, which accounts for most of Canpotex's sales.

Still, all of these factors likely do not outweigh the price cut.  So what happened?  It's possible that Canpotex simply got outmaneuvered, or that the current supply/demand balance is tipped too far in favor of buyers.  But Canpotex may have forfeited a battle in order to win the war.  The most serious long-term threat to potash producers is the risk of oversupply.  Over the next year, BHP Billiton will decide whether to go forward with its potentially massive Jansen mine.  The project is expected to be very expensive, and cannot be justified unless potash prices are far higher than the present $400 per tonne.  To be sure, what matters most is where potash prices are seven or more years down the road, but it’s difficult to allocate $5 billion - and perhaps much more, in this case - without seeing prices rise and stay up for a period of time.  Only time will tell, but the reduced price may be enough to scare off new production, at least for a few more years.

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.

Poseidon Concepts - Value or Value Trap?

The average company trades for about 15 times earnings.  What if I told you about a company that was trading not for 10 times earnings, not for 7 times earnings, but for 4 times earnings?  Oh, and that's 4 times quarterly earnings - just over 1 times dividends.  Sound too good to be true?  It's kind of true - but, alas, it's also sort of too good to be true.  The dividend in question was recently suspended, and the quarterly earnings, unfortunately were not from the most recent quarter, or, perhaps, for any quarter in the foreseeable future.  Let me explain.

The company in question is Poseidon Concepts.  Spun out of Open Range Energy last year, Poseidon experienced astronomical growth by offering oil and gas companies a simple, but very efficient, alternative to storing water used for drilling.  Employing a device not unlike an above ground pool, Poseidon’s novel concept was not only cheaper, it was quicker and less environmentally risky than the standard methods then being used.  In an impossibly short period of time, Poseidon had a foothold in most major North American plays.

The high point came in this year's first and second quarters - the same quarters mentioned above - when earnings per share were $0.38 in each period, and funds from operations were $0.49 and $0.48, respectively.  Until only this past week, the company paid a dividend of $0.09 per month, or $1.08 per year, within reach of the current share price, which has fallen by a gut-wrenching 90%-plus from its high.  What a difference a quarter makes.  By the third quarter, Poseidon's net income had fallen to just $0.10, in part due to a $9 million charge for bad debts that the company is unlikely to collect on.

What happened?  It appears the company was hit on two fronts.  Not only has demand been weak industry-wide, increased competition pushed down margins, too.  Indeed, some firms in the industry have been forced to offer discounts of up to 75%, a sure sign of a commodity-type offering.  Though the company holds a patent on its main product - which is responsible for the bulk of its business - it doesn't appear that it will prevent competitors from offering similar items.  And there was never any doubt that the high margins and returns on capital that Poseidon has enjoyed would invite salivating rivals.  To be sure, the company is rightly trying to use their installed base of storage tanks as a foundation from which to sell added products and services, but it remains to be seen if they will be successful in a fast-changing market.

Clearly, there have also been some troubles specific to Poseidon, as well.  For one, it appears that the recent wild growth was faster than management could handle.  Indeed, at the end of the third quarter, receivables were $126 million, compared to revenue in the first nine months of the year of $148 million.  On such a large base of uncollected cash, further write-downs could be immense.  At the end of the third quarter, $36 million of Poseidon's receivables were past due, a worrisome figure, particularly after having written off $9 million altogether.  Though receivables in the oil and gas services industry are regarded as difficult to collect on, competitors have not suffered nearly to the extent that Poseidon has.  Painful as it must have been, however, the newly arranged board has made the right decision to suspend the dividend, which will give them much more liquidity, buying precious time to - hopefully - right the ship.  In addition, at the end of the third quarter, $44 million remained undrawn on the company's credit facility, which doesn't come due until June of 2014.

The changes at the top are unusual.  Scott Dawson, former CEO of Open Range Energy and current Chairman of Poseidon will step into the CEO role immediately.  Lyle Michaluk will move from the CEO role into the CFO role, which is unusual in such cases - after all, most ousted CEOs are not offered another senior executive position, nor would they ordinarily be interested in accepting one.  Similarly, Cliff Weibe will assume the role of Chief Technology Officer, having until recently served as the Chief Operating Officer.  Both men, as well as one other director, have resigned from the board.  On a positive note, if there was reason to suspect any major ethical breaches or wrongdoing, it's virtually impossible that any of the above officers would have been offered alternative positions.  Based on the facts available, it seems reasonable to conclude that the company simply grew too fast for the management team, and the company's processes and system of controls, to handle.  In the third quarter report, the company, to its credit, admitted to weaknesses in internal controls, specifically a lack of accounting expertise, and pledged to remedy to problem as soon as possible.

Is the stock a buy at today's dramatically reduced price?  It's impossible to know - which means, "No."  Wise investors only commit hard-earned capital if the odds of permanent impairment are low - for now, the picture is simply too fuzzy to rule out that possibility.  As Warren Buffett has often said, the first rule of investing is "Don't lose money," and the second rule is "Don't forget the first rule."  Many bottom-feeding investors may be tempted to scavenge on Poseidon's shares, knowing that if the story works out they could enjoy a radically high return.  But if they look down first they will likely find that they're not protected by a margin of safety, and ignoring the risk while dreaming about the upside is foolish.  If things turn for the better in the months to come, there will likely be an opportunity to buy shares at a higher, but still bargain price, with the confidence that any mortal danger the company may now be facing has passed.

 

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Valuing the New Leucadia National

It's difficult to value companies like Leucadia National, which has elements of a conglomerate, a hedge fund and a private equity firm all at the same time.  Wholly owned operating businesses in a range of industries, common stock positions, royalty streams - Leucadia has used a wide net when fishing for value opportunities.  In the past, shareholders tended to use book value as a rough proxy for intrinsic value, with the stock price moving roughly in tandem with shareholder's equity over long periods of time.  However, there have also been long stretches when the share price has traded significantly above and below book value.

The recently announced merger with Jefferies, combined with the 2011 purchase of National Beef, means that the operating business component of Leucadia's value has expanded markedly, and the approach to valuing the company must be revisited.  The appropriate way to value the company is probably to attach a multiple to operating earnings and add it to book value.  Upon the announcement of the merger, Leucadia estimated its combined business will have a book value of $9.3 billion, or $24.69 per share (including the dilutive effect of shares issued in the merger transaction).  Net to Leucadia, its four largest operating businesses - Jefferies, National Beef, Berkadia and Garcadia - currently produce roughly $480 million in combined after-tax earnings.  A 12x multiple would make this earnings stream worth around $5.8 billion or about $15 per share.  Leucadia, then, may be worth around $40 per share, significantly higher than it currently trades for.

Whatever the method Leucadia's managers themselves use to value their business, they must agree that the business is undervalued - after all, they recently initiated a share repurchase program.  Wise investors will consider allocating some of their own wealth alongside one of the finest collections of investing talent in the world.

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Leucadia National and Jefferies to Merge - An Analysis

Several weeks ago, an admirable case study in the history of value investing came to an end - at least the long and satisfying first part did.  Leucadia National, long stewarded by the two-man team of Ian Cumming and Joseph Steinberg, merged with Jefferies, a leading mid-sized investment bank.  Technically, Leucadia swallowed Jefferies - at least the 71% that it hadn't already digested - but in some ways it feels like the reverse.  After all, not only will Jefferies become the anchor company in Leucadia's collection of businesses, Jefferies' chief executive Richard Handler will become CEO of Leucadia, as well as remaining at the helm of his own firm.  Ian Cumming will retire from his day-to-day role, while remaining a director, though Steinberg and the rest of Leucadia's senior management will remain on board.

Why the change?  Clearly, succession played a large part in the move.  Leucadia's aging masters weren't going to be around forever, after all.  In fact, Cumming had already signaled his intention to retire by declining to extend his contract past 2015.  Steinberg, however, will remain with Leucadia, both as Chairman and as an active executive, and has (to this writer's knowledge) not made public when he plans to move on.  Evidently, the opportunity to hand over the CEO role to a young and able manager with many years ahead of him was one that Cumming and Steinberg couldn't pass up.  Leucadia shareholders can take comfort in the fact that they've worked with Handler and his team for many years.  Indeed, they've enjoyed a personal relationship for more than 20 years, and an active business relationship for more than a decade.  Handler, for his part, regards Cumming and Steinberg as valued mentors.  Given that Leucadia's wholly owned operating businesses are run at the company level, and most of the company's senior managers will remain, Handler should be able to manage his newly expanded role.

How will the two businesses fit together?  Many mergers are sold on the basis of "synergies" that often fail to materialize, but Handler actively downplayed this motivation.  However, there are several areas where this merger could make 1+1 equal more than 2.  First, the deal flow that Jefferies is involved in will unearth opportunities for Leucadia that would otherwise not be available.  In fact, this has already happened in the past - Leucadia's investment in Fortescue, for example - thanks to the longstanding relationship between the respective companies and management teams.  Second, Leucadia has a large net operating loss, an asset that it can't quickly capitalize on without more operating earnings.  The new company, however, is expected to fully utilize the NOL over the next several years, which will turn it from a theoretical balance sheet item into cold, hard cash.  Finally, being part of a large and strong company such as Leucadia may allow Jefferies to escape the vicissitudes of the market, such as the one it suffered from in 2011, where the company looked to be in mortal danger for a short period of time, despite being fundamentally sound.  For a smaller investment bank, the mere perception that it's suffering financial distress, however false, can quickly create that very reality.  This will be less likely to happen as a part of Leucadia, though not impossible. 

While Leucadia will look very different in the future than it has in the past, the company has always been evolving, never staying the same for very long.  (Surprisingly, Handler stated only that he hoped that Jefferies will remain a part of Leucadia for the long-term, whereas many shareholders might have assumed that the two companies would be permanently married; this is a notable difference from Berkshire Hathaway, to which Leucadia has often been compared, which makes a promise of forever when it acquires a business).  What has remained constant, though, is a superb management team with the knowledge and temperament to take advantage of opportunities to create value for shareholders, in whatever form they arise.  Only time will tell if Handler is up to the challenge, but the ongoing presence of most of Leucadia's top brass is likely to mean a continuity of values, philosophy and process, even if the Leucadia's next chapter has a few unexpected plot twists in the future.

 

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Glacier Media - 2012 Q3 Update

After accounting for one-time items, and the seasonality of the assets acquired last year from Postmedia, Glacier Media posted solid results in the third quarter.  The company's focus on local newspapers, as well as business and trade publications that consumers are willing to pay for, means that it's largely able to escape the pressures suffered by larger papers that compete infinite alternatives, many of them free of charge.  Still, the soft national advertising market in Canada has some effect on Glacier Media, as it has all year.

Glacier has a glowing opportunity to create value for shareholders over the next few years, even in the absence of any new acquisitions.  With $131 million, or $1.47 per share in net debt ($27 million of it's non-recourse), management can add significant value simply by paying it down.  In addition, the company intends to repurchase shares, and increase the dividend over time.  In fact, management offered a fairly strong hint that a dividend increase is forthcoming, noting that the topic will be addressed in early 2013. 

At today's payout level of $0.06 per year, Glacier Media's stock offers investors a dividend yield of about 3.5%, significantly higher than the market's average yield, which has long stood at about 2%.  If the dividend were increased even to $0.08 per annum, the yield would jump to 4.5% at the current share price.  Given the general wariness about newspapers and similar content, it's possible that Glacier Media will behave more like a trust than a stock, with significant income, but less than dramatic share price performance.  No matter: for a company that throws off $0.40 or so in free cash flow, there's ample room to increase the dividend; shareholders that reinvest the dividend will do well over time.  And eventually stellar performance will surely mean some upward movement in the stock price, too.

My original analysis of Glacier Media is here.

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.