Glacier Media - 2012 Second Quarter Update

As usual, Glacier Media recently reported strong results for the second quarter of 2012.  Quarter-over-quarter sales were up 27.4%, though EBITDA increased at a more modest 12.1%, and cash flows increased by 10.8%.  These latter two figures are more important than the robust increase in revenues, and are largely explained by lingering weakness in the assets acquired from Postmedia late last year. 

However, these same properties offer an opportunity to grow over time simply by making much-needed operational improvements, which can be achieved with only modest incremental investments.  Because of a substantial debt load, the previous owner cut costs to the point that the product was weakened.  Glacier, while always conscious of costs, carefully avoids diminishing the editorial product that readers and advertisers expect, and it doesn't it allow sales capacity to wane.  There are straightforward steps that can and are being taken, with some encouraging early results.

Consolidated net debt fell to $137 million in the quarter, and now stands at about 2.5x trailing twelve months EBITDA, a significant but manageable amount of obligations.  At $6.9 million, capital spending was significantly higher than usual in the quarter, though the vast majority of outlays were for investment, rather than maintenance, mostly for a new printing press.  Management expects these heightened expenditures, which should fall by the first quarter of 2013, to generate both sales growth and cost savings.  Unfortunately, the company was not able to repurchase any shares, which remain dirt-cheap, though management correctly prioritizes debt repayment above buybacks.

One of the most important tasks for management over the next few years is to wring enhanced profits from the Postmedia assets.  Given their consistent past success in doing so, and encouraging early results, shareholders can be confident that Glacier's leadership team will do just that.  Here's looking forward to the third quarter.

My original write-up on 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.

ATP Oil and Gas - Imminent Bankruptcy

It appears that ATP Oil and Gas will be forced to restructure via a bankruptcy filing in the coming weeks, the Wall Street Journal is reporting.  Shares are trading well into penny-stock territory, at just $0.36.  Negotiations are said to be ongoing with senior creditors, and the company delayed its second quarter filing until matters become more clear.  The company will obtain a $600 million loan to remain liquid during legal proceedings.

At this point it’s unclear what, if anything, might be left over for the disheartened – and now impoverished – owners of the common stock.  The stock once traded at well above $50, and it’s a harsh reminder that “debt” can be the cruelest four-letter word in the English language.

My original write-up on ATP Oil and Gas is here.

Disclosure: At the time this article was published, the author was long ATP Oil and Gas options.

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.

Profile - Tom Stanley

From 1993 to 2006 Tom Stanley's Resolute Growth Fund returned a staggering 29.63% per annum.  The lucky and grateful investors who were carried along for the entire ride enjoyed a total return of better than 25-to-1.  Over the same span, the TSX returned a touch above 10% per year, or about 3.5-to-1.  Importantly, only about half that timeframe straddled the long bull run that lasted from the early 1980s to the late 1990s.  Between the Dot Com bubble and the current crisis, stock market performance overall was distinctly mediocre, while Stanley's performance was outstanding.  Indeed, over the eight-year period from 1999 through 2006, he returned 46.25% per year (1).  To be sure, his performance since has been more pedestrian, but whose hasn't?  Such impressive returns put Stanley among North America's finest investors. 

Despite such impressive performance, few students of investing are likely to have heard of him, particularly if they reside outside of Canada.  Stanley doesn't do much media, and will not be found revealing his top picks on BNN Market Call or similar forums, so his ideas, alas, aren't readily available to copycat investors.  Even investors situated within the corridors of Canada's financial power might not know him.  Instead of operating out of a glitzy Bay Street high-rise, Stanley's shop is in a nondescript office far from the heart of Toronto's financial district.  However, there's much to learn from his experience and philosophy.  Though Stanley is justifiably tight-lipped about the specific stocks that he's invested in, he openly shares his principles of investing, and has posted them on his website.

It's not just his performance that distinguishes Stanley from most other investors.  He has conviction.  Everyone talks a big game about their undying commitment to clients; Stanley backs up his words with honorable actions.  He charges a paltry 2% management fee (which includes all expenses), an anachronism in the era of 2-and-20 hedge fund managers, most of whom charge fees of 2% of assets per year, regardless of performance, plus 20% of any gains.  He launched a fund that catered not to rich investors, but to ordinary ones, and held Town Hall-style meetings once per year to engage with them face-to-face, not all that different from one of his major influences, Warren Buffett (Stanley cites Charlie Munger, Peter Lynch and John Templeton as his other role models).  Most notably, when interest in his fund soared, he made the self-uninterested decision to close it to new investors.  The bigger a fund is, the harder it is to grow at above average rates, after all.  Stanley preferred to give clients the chance to gain outsized returns, even if it meant earning less himself. 

Buffett's influence is apparent elsewhere, too.  Stanley has a knack for catching trends before most other market actors know there's a pattern at all.  For example, he understood more than a decade ago that oil was likely to rise significantly, and outlined his reasoning in a letter to clients dated October 11, 2000.  His case was straightforward: inflation-adjusted oil prices were low, which depressed industry profits, and spare capacity was limited, meaning that new supply was unlikely to both replace depleting wells and meet growing demand unless prices rose (2).  He was able to find small-cap energy producers that were trading for just two or three times cash flows (3).  During the same period, many investors were wild about high-tech stocks, and some of Stanley's own clients encouraged him to add Dot Coms to his portfolio.  He refused.  However, contrarianism sometimes masquerades as independence, and Stanley understands the difference.  Indeed, one of his principles is: "You don't have to win by being original, you win by being right" (4).
Stanley concentrated heavily in a few ideas - sometimes his entire fund is invested in less than 10 stocks - and ignores the conventional advice to rebalance his portfolio constantly, so that positions are evenly weighted.  In fact, in 1996 one name - and not a household name, either - accounted for 36% of his fund's assets.  Predictably enough given such concentration, his fund has dropped by 25% or more on several occasions.  However, he credits much of his success to just a few ideas.  On the other hand, he's one of the rare money managers who's admitted that he would liquidate his entire portfolio and sit on 100% cash if market conditions warranted it (5).

Citing Buffett's notion of staying within one's "circle of competence," Stanley rarely strays outside of Canada when making investments.  Though he doesn't have a firm rule against investing elsewhere, he believes that he has access to better information about local businesses, and a more in-depth understanding of political and economic issues, in Canada.  His sterling record is all the more impressive, given Canada's more limited pool of public companies than there are in, say, the US.
One surprising area where Stanley appears to differ from Buffett is in the quality of the businesses he invests in.  Many of the names that Stanley has invested do not appear to be of the highest caliber.  The Oracle of Omaha insists on buying only the best businesses, ones that enjoy a durable competitive advantage; Stanley has little to say on the matter, but many of the names that he's invested in that are public knowledge would be unlikely candidates for Morningstar's "Wide Moat" index.  At least, the last time I checked, UTX, International Uranium and Cangene weren't on that rarified list.  Most of them were bought on the cheap, however, rather like the companies Ben Graham - and the pre-Munger Buffett - preferred to buy, though they don't seem to be as dismal as the "cigar butts" that Graham scavenged for.  Stanley finds undervalued stocks largely by searching for ignored small cap stocks that have fallen under the institutional radar.

Like many formidable investors, Stanley doesn't fit in any conventional mold.  For example, he proves (again) that it's a myth that investors must have an accounting background, or a formal education in business, to have success.  Charlie Munger studied Law (he didn't receive an undergraduate degree at all, but was admitted into Harvard's law school thanks to the intervention of a family friend); Bill Miller studied Philosophy at the graduate level; and the late Barton Biggs majored in English Literature.  Stanley, for his part, focused on Psychology as an undergraduate, though he later supplemented his studies with an MBA.  He's of the view that most people's brains are not wired to invest well, and he pays close attention to the research that explores the psychology of investing (6).  The insights from behavioral finance, combined with what he has gleaned from investors both prominent and private, with a lot of independent thinking, too, have produced a rare and special investor in Tom Stanley.


Sources: (1) (2) (4): http://www.resolutefunds.com/
(3) Thompson, Bob. Stock Market Superstars: Secrets of Canada's Top Stock Pickers. Toronto: Insomniac Press, 2008, p305

(5) Thompson, p319-20

(6) Thompson, p293

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.

Profile - James Surowiecki

Surprisingly, considering how consistently brilliant, insightful and original James Surowiecki is, it's almost possible to overlook him.  Perhaps this paradox is because of style.  He writes a regular financial article for the New Yorker, and despite the five-star quality of that magazine's contributors, its prose tends to be a tad homogenous, with the exception of its fiction.  His writing is difficult to distinguish from his colleagues, too.  But consistency isn't a bad thing, not if it means a reliably lively and fine product.  But enough about style; it's the content of Surowiecki's thoughts that makes him worth reading. 

Surowiecki is strong not only in traditionally-defined areas of study, such as investing, economics, finance, and politics, but also in cross-disciplinary areas, including behavioral finance and neuroeconomics.  He brings a fact-based and analytical perspective to the topic of investing, an emotionally-charged field ever in need of cool-headed counsel.  In an article called, "All Together Now" (June 9 & 16, 2008) he briskly sums up the grim history of mergers and acquisitions (most fail, at least for the acquiring companies, in large part because take-over premiums are too high), he points to factors most likely to make a purchase work out (cost-cutting pledges are easier to deliver on than promises of growth) and he suggests alternatives (joint ventures and partnerships can be very worthwhile for both sides of an alliance).

Investing and economics are intimately intertwined with politics, another discipline that Surowiecki is well-informed on.  He has a deep understanding of America's government, constitutional issues and political history, but he's also alert to the humdrum workings of day-to-day US politics.  He shows his command of several of these areas in "Greedy Geezers?" (November 22, 2010) where he explores the "I've got mine - good luck getting yours" ethos that prevailed among seniors when they overwhelmingly voted for Republicans in the 2010 Congressional election, in part over Obamacare.  After all, older voters wanted to keep Medicare, but deny it to newcomers, despite having enjoyed financial benefits far greater than their earlier contributions.  Citing work by Benjamin Freidman, Surowiecki explains the mid-term result as a recent example in a long-running pattern: economic stagnation often prompts people to become protective of their own interests, hostile to outsiders and dismissive of social welfare.  Surowiecki is also very familiar with foreign political economy.

Surowiecki remains up-to-the-minute on cutting-edge research.  For example, in "Smash the Ceiling," (August 1, 2011), when there was some doubt about whether Congress would vote to increase the debt ceiling, he warns that recent work from the field of psychology has shown that the pressure of a deadline closes minds, rather than opens them, and typically has the effect of reinforcing stereotypes.  He also alludes to work from economics suggesting that it's often effective to make the other side in a negotiation believe that you're a little crazy, in order to bluff them into accepting better terms - as he puts it, "recklessness does equal power."  It's hardly surprising, then, that no authentic progress has been made since, though the leverage limit was eventually increased. 

Drawing on his deep knowledge, he routinely mounts convincing challenges to conventional wisdom.  For example, he points out in "The More the Merrier" (March 26, 2012) that cutting costs doesn't automatically lead to increased profits, despite the "leaner-is-better" mentality that has become dominant among CEOs.  In the retail sector in particular, customer service is of paramount importance: shoppers want knowledgeable employees and short lineups, for instance, and will pay for them in the form of more purchases, a lesson that Home Depot and Circuit City failed to grasp in their ax-wielding days.  He argues convincingly elsewhere that the NFL is operates rather like trusts did in the nineteenth century before they were banned: they enjoy "a socialist paradise for themselves that happens to bring with it capitalist-size profits" ("Scrimmage," March 21, 2011).

He also has a knack for adding a well-placed detail to spice up an article.  For example, in "Dodger Mania" (July 11 & 18, 2011), which addresses the rampant tax evasion and general corruption in Greece, he reports that authorities have begun to fly overhead in helicopters looking for swimming pools, a dependable sign of wealth.  In response, well-to-do Greeks entered the market en masse looking for camouflage pool covers.  In an even more troubled part of the world, the young Tunisian man who set himself ablaze - and set history into motion - had recently had his fruit cart confiscated for violating some rule or regulation, a sign of broader economic dysfunction in the Middle East ("The Tyrant Tax," March 7, 2011).

Surowiecki's column is only a single page long, 1000 or so words, but he's able to cover an amazing amount of material.  Though he regularly comments on topical and "trending" issues, his useful references to slowly-evolving history and theory mean that his work has enduring value, even if some of the examples he cites may fall from memory with the ever-changing news cycle.  In short, an effort to collect a number of his articles in a book-length edition would be a valuable undertaking.  Until then, wisdom-seeking readers should reach for a copy of the New Yorker, or visit Newyorker.com, themselves.

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 Corp - 2012 Second Quater Update

Potash Corp recently reported what would have been record second quarter earnings, but for a write-down in one of the company’s common stock investments.  The year is likely to finish strong, and the company left earnings guidance unchanged, ignoring the effect of the earnings charge.  Business figures to strengthen further in the years to come, as well.

Recent drought conditions in the US have served as a reminder that food doesn't magically appear on people's plates - an obvious fact, but one that many often forget.  Supply shortfalls naturally elevate prices, and as the price of agricultural commodities increase, so does the demand for fertilizer.  Any forgone food production today will require increased fertilizer use in the future, over a multi-year time horizon.  Potash has the added benefit of helping to protect crops from stress, including weather-related troubles.

As the CEO of the industry's leading company, who also serves as the President of the International Fertilizer Industry Association, Bill Doyle has access to an imposing pair of soapboxes; when he speaks, people listen.  Though he is honest and plain-spoken, Doyle uses conference calls in part to maneuver and negotiate with  potash buyers, particularly China and India, the only major countries that buy on contract, with volumes and prices agreed upon before delivery (most buyers purchase their product as needed on the spot market).  He firmly stated on the conference call, for example, that potash prices will be heading upward, beginning now and extending for years to come.  But coming from Doyle this is not a passive prediction from someone sitting on the sidelines, it's a pledge that Potash Corp will be increasing prices.  Considering the industry's disciplined supply management, the newly diminished US crop, and the relentlessly increasing demand from hungry people, it's a safe bet that forthcoming price increases will stick.

However, Potash Corp announced that its capital expansion program is now expected to cost $8.2 billion, up from past estimates of $7.7 billion, thanks to the perverse incentives of cost-plus construction contracts.  While $500 million is a large number, even for a giant company, shareholders have a few reasons to at least feel ambivalent about the news.  For one, the new supply is still expected to arrive on schedule.  Second, with 78% of the capital expansions complete, there's a limit to future expenses.  And most importantly, it's an indication of the substantial cost, and technical difficulty, of bringing on new supply.  This is a plus for all incumbent producers, but is disappointing to would-be competitors that have never actually been in the challenging business of producing potash, and will not be immune themselves to the inflationary consequences of cost-plus work.

My original write-up on 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.

ATP Oil and Gas - Looming Bankruptcy?

Shares of ATP Oil and Gas have been further pummeled in recent days, as many investors – and bondholders – believe that the threat of bankruptcy has increased from possible to likely.  Though the largest chunk of ATP’s debt doesn’t come due until 2015, the worry is that the company will not be able to make its interest payment in November of this year.

Bloomberg reported yesterday that a group of bondholders has interviewed advisors about the best way to approach a restructuring.  In addition, Streetinsider.com reported today, “According to Bloomberg, a group of bondholders are forming a group following delay in payment of interest on held debt.”  This appears to be a mistake, however, as the Bloomberg article says nothing of an actual delayed payment, it only addresses the fear among some bondholders that it will be unable to make the next $89 million debt payment come November.  Adding to fears were reports earlier in the week that ATP has hired Jefferies to assist them in their efforts to avoid a cash crunch.  The company hasn’t responded to requests for comment.

According to past comments from management - perhaps something has since changed - between now and November, the company expects to: 1) complete a sleeve shift on the A1 well at Telemark; 2) close a deal to finance/monetize the Octubouy platform; and, 3) bring 16.2 mboe/day of oil-heavy production at Clipper by late September/early October.  (If Clipper meets expectations the company could be producing around 45 000 boe/day.  Assuming a $50 cash flow margin, ATP would be generating over $800 million in cash flow, not including royalties and overrides.  The key question, though, is how much cash will belong to ATP including these claims on their cash). 

The company has continued to be able to add to liquidity in recent weeks, though on less attractive terms.  Fears of bankruptcy are nothing new for ATP, fears that have so far not come true.  However, without discovering what - if anything - has changed, its impossible to tell whether these are the last dark days before a new dawn, or if the company is doomed.

My original write-up on ATP Oil and Gas is here.

Disclosure: At the time this article was published, the author was long ATP Oil and Gas options.

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.

Glacier Media - Investment Analysis

Glacier Media Inc. is an information communications company that provides primary and essential information and related services through print, electronic and online media. Specifically, Glacier operates in three core business segments: local newspapers, trade information, and the business and professional information sectors.

Local Newspapers

Glacier's newspapers provide content to small, underserved local markets, where there are few, if any, competitors.  While the Medicine Hat News may not be known for its editorial gravitas, and may not treat readers to Pulitzer Prize-winning reporting, it is a primary source of information in its market, and, like many similar papers, has been a source of community-focused news for decades.  People will always be interested in what's happening in their local community, and advertisers will always be interested in reaching them, so the demand for these papers will exist for the long-term. 

This will likely allow small and some medium-sized community newspapers to avoid the dark fate of large metropolitan newspapers, which cover a broad range of regional, national and global issues, and compete with innumerable sources, most of which make their contently freely available online.  Glacier's free-of-charge local newspapers generate sales from advertising, not subscriptions, and the company doesn't depend on declining paid classified advertising.  Since most of Glacier's properties are situated in energy-rich Western Canada, the company is likely to enjoy a strong macroeconomic tailwind in the future.  In addition, the geographical concentration offers opportunities to sell regional and national-scale advertising, as well as other revenue and cost synergies.

Trade Information, Business and Professional Information

Financial publications occupy a rare niche, many of which have been able to prosper even while charging for content, and this commercial exemption doesn’t just apply to the big-name indispensables, such as the Wall Street Journal, the Financial Times of London and the Economist.  Glacier, for example, offers paid trade and business publications - notably The Western Producer, a go-to source for agribusiness coverage in Western Canada - largely in the areas of agriculture, energy and mining.  In many cases, these publications provide information that's necessary to managers, businesspeople and investors if they're to make informed decisions.  As long as these high-quality sources make money for their readers, they'll be able to charge money for their product. 

Return on Equity

Glacier's adjusted return on tangible equity has averaged over 100% for many years in the past, far exceeding the 10-12% that most businesses earn.

Management

Investors in Glacier Media have little opportunity to get a first-hand feel for the senior managers: they don't hold forth on quarterly conference calls, they don't address analysts on the road-show circuit - indeed, they don't make any media appearances, at all.  The primary direct communication with shareholders comes in the President's Message section that leads off all quarterly and annual reports.  However, as with many who have an "actions-speak-louder-than-words" philosophy, Glacier's managers have forged a fabulous record in lieu of lofty verbal pronouncements. 

They have a superb record of capital allocation.  For the most part, the excess cash flow that Glacier has generated has been used to make acquisitions.  The acquisitions have been successful, as they have been made at attractive prices with a high return on capital.  When they have not made acquisitions, the company has paid down debt, repurchased stock (though, importantly, only when the stock has been undervalued) and it pays a healthy dividend.

They've also shown an admirable streak of independent thinking.  For example, despite the omni-presence of the internet, and the many obvious advantages it offers to news consumers, many continue to enjoy reading dead-tree newspapers, and advertisers continue to find the medium useful, too.  In addition, the physical presence of such publications serves as a marketing vehicle to maintain brand awareness and to drive online activity.

There's a noteworthy reason management consistently acts in the interests of shareholders: because they're owners too.  Indeed, Chairman Sam Grippo, CEO Jonathon Kennedy and one other Director together own 34% of Glacier's outstanding stock.

Price

Glacier's maintenance capital expenditures are in the neighborhood of $5 million, so in 2011 free cash flow amounted to $0.44 per share.  The company's large acquisition of several Postmedia properties closed late in the year, so very little profit from the new purchase made it into 2011's final tally.  It would not be outlandish, then, to assume FCF of around $0.55 in 2012.  Net debt as of the first quarter of 2012 was $1.40 per share, giving the company an enterprise value of $3.50-3.70 or so at the stock's recent market price.  Conservatively projecting that Glacier generates $0.55 of FCF in 2012, $0.60 in 2013 and $0.65 in 2014, and assuming that the company does nothing but pay down debt, where would that leave shareholders at the end of that timeframe? 

In this scenario, debt would be paid down entirely, with a total of $0.40 to spare.  Assuming a 12x multiple on $0.65, the shares would trade for nearly $8.00.  Importantly, with no debt on the balance sheet, all FCF would be available to return to shareholders.  FCF of $0.65 on today's share price would be the equivalent of having a bond with a coupon of over 30%.  Not bad for a steady, low-risk investment.  (In practice, of course, the future will unfold at least somewhat differently: the company will almost certainly close more acquisitions over the next few years, for instance).

Conclusion

Warren Buffett, who once considered newspapers among the finest possible investments, later lamented that competition from cable and satellite channels, and especially from the internet, had made the long-term economics of the industry "terrible."  Recently, however, he's reentered certain corners of the newspaper market, though only on a small scale.  In areas where there's a strong and enduring sense of community - for example, in his own hometown of Omaha, where he recently bought the World-Herald - newspapers have a good chance to remain profitable for the long-term.  Few people can make the same boast as Glacier's management: they beat the Oracle of Omaha to this insight.

It may become more difficult for Glacier to grow by (cheap) acquisition in the future, now that there's a broader understanding that not all newspapers face a bleak financial future.  However, Glacier's existing assets, management team and stock price offer a low-risk, high-reward opportunity for investors.

Sources: 2011 Annual Report, 2012 Q1 Report

There's ongoing commentary on Glacier Media: A 2012 Q2 update; a 2012 Q3 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.

The Opportunities in Spin-offs

Spinoffs can take many forms, but usually involve a conglomerate breaking one collection of businesses into two or more smaller ones, or a parent company carving out a subsidiary or large division to operate independently.  The major motivation is the hope that the businesses will be valued higher separately than together.  Conglomerates, for example, often own businesses of varying quality in several different industries.  Since investors cannot invest directly in the top-tier companies without also taking a stake in the dogs, many will ignore the company altogether, and the share price will remain depressed.  Mary Buffett and David Clark liken it to finding "hidden diamonds wrapped in ugly coal" (Arbitrage, p115).  Spinoffs allow investors to attach an appropriate value to each business, and even accounting for the fact the poor businesses will be valued accordingly, the collection of freestanding businesses will often be trade at a higher value than the single entity did.

Spinoffs are currently back in vogue.  In the past year or two, a number of large and familiar companies have decided to break up into two or more smaller entities.  Kraft Foods, for example, decided to separate its fast-growing snacks business from its steadier, but slower moving, grocery operation.  ConocoPhilips separated its downstream assets, which include refining, marketing and chemicals, from its exploration and production business.  Recently, News Corp decided to divide its publishing arm from its entertainment businesses.  Wise investors will take a long look at these - and similar - opportunities.  After all, a number of prominent and successful investors have found opportunity in spin-offs, including Peter Lynch, Joel Greenblatt and Warren Buffett. 

The case for spin-offs is compelling.  Joel Greenblatt cites one study, covering a twenty-five year period ending in 1988, which showed that spinoffs outperformed the index by 10% per year in the first three years as stand-alone businesses.  The stock market has returned 7-8% per year over the long-term.  A random basket of spinoffs would return a much more attractive 17-18% per year.  This is a major difference.  $1000 growing 7.5% per year would amount to $8755 after 30 years; that same amount growing for 30 years at 17.5% would be worth a staggering $126 222, more than 14 times the alternative.  And truly ambitious investors will try to do still better: rather than settling for the indiscriminate bunch of spin-offs, separating the ordinary from the most appealing might earn a few extra percentage points per year.  An additional three percentage points would bump up the annual return to 20.5%, and boost the overall amount to $260 913.

Why is this so?  In part, it's due to multiple expansion: a diamond covered in soot is likely to be valued like coal, but when the two are separated, the hidden gem will command a sparkling P/E ratio.  The underlying business itself has a good chance of improving, too.  Free to succeed or fail on its own, a newly-divested company will benefit from the full-time focus of management, and the entrepreneurial forces that may have been stunted within a large and lumbering bureaucracy can be unleashed.  In some cases, financial engineering will be used to distinguish the good from the bad and the ugly.  For example, sometimes one of the newly single companies will be deliberately overloaded with debt, freeing the remaining business(es) from the burden of leverage.  Of course, this sort of idea can easily be taken too far, and an excessively debt-laden company may not be able to survive.

There are different ways to go about investing in spin-offs.  In Warren Buffett and the Art of Stock Arbitrage, the authors report that Buffett prefers to buy stock in the parent company before a spin-off is executed; afterward, he sells the parent and keeps the coveted small-fry.  For example, when Dun & Bradstreet spun off Moody's over a decade ago, Buffett bought-then-sold the parent, and held his interest in Moody's, a position that has since trounced the overall market, and which he continues to hold.

Greenblatt, however, tends to buy spun off businesses after the transaction has occurred.  Most spin-offs are much smaller than the parent, though most investors are interested primarily in the larger business.  When the new business is divested, many will suddenly hold a position in an unwanted company.  (Shareholders will own a proportionate stake in all companies after such a transaction: an investor who owned 1% of the parent company before the spin-offs, for instance, will own 1% of each different company afterward).  Moreover, many institutional investors are too large to bother with a small company, or they are banned by statute from holding businesses below a certain threshold (say, under $1 billion in market capitalization).  The automatic selling usually puts downward pressure on the spun out stock in the first year or so after the transaction.  For Greenblatt, buying at depressed prices in the inaugural year is ideal.  As a bonus, at about the time the knee-jerk selling ends, some of the typical improvements in the underlying business begin to bear fruit, and the stock often heads upward.

Greenblatt has found other ways to profit from spin-offs, too, including by investing in the parent companies, by buying into some of the highly-leveraged businesses seemingly left to die, and by devoting capital to partial spin-offs.  Profit-hungry investors would be wise to read Greenblatt's book You Can Be a Stock Market Genius.  Not only is it one of the finest investing books ever conceived, the chapter on spin-offs offers the best coverage on the topic I've yet read, including several long and fascinating case studies from his career. 

There are thousands of publically traded corporations in North America, many of which are bought, merged and sold every day, making it difficult to track pending spinoffs.  Happily, there are several websites devoted to following them.  After a company announces a spin-off, regulatory filings will be published that outline at least the broad financial performance of the soon-to-be-separate businesses.  Investors that routinely consult these filings will find a world of opportunity, at least over a long period of time.

I wrote an earlier book review of Warren Buffett and the Art of Stock Arbitrage.

Sources: (1) Buffett, Mary and Clark, David. Warren Buffett and the Art of Stock Arbitrage: Proven Strategies for Arbitrage and Other Special Investment Situations. New York: Simon & Schuster, 2010.

(2) Greenblatt, Joel.  You Can be a Stock Market Genius: Uncover the Secret Hiding Places of Stock Market Profits. New York: Simon & Schuster, 1997.

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

ATP Oil and Gas - Workover Success at Telemark

Though it came a week or so later than promised, ATP Oil and Gas delivered today on its pledge to increase production at the Mississippi Canyon Block 941 A-2 well.  Initial flow rates were 4000 boe/day, with a very attractive 90% of it in the form of oil.  Better still, the well is expected to produce in a range of 4000-5000 boe/day. 

Based on past statements, the company will now complete a sleeve shift on the A-1 well over the next few days.  If and when that occurs, the ATP will likely have achieved added production at the top end of the targeted 4000-7000 boe/day range.

Given the problems that have plagued the company at Telemark, it remains to be seen whether production meets expectations.  However, long-suffering ATP shareholders have reason to be cautiously optimistic, given the recent success in Israel, as well as today’s announcement.

My original write-up on ATP Oil and Gas is here.

Disclosure: At the time this article was published, the author was long ATP Oil and Gas options.

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 - Poor Charlie's Almanack: The Wit and Wisdom of Charles T. Munger, edited by Peter Kaufman

The printing press, the steam engine, the telephone, the automobile, the radio - everyone agrees that these were not ordinary inventions, but giant steps forward for mankind.  Charlie Munger is virtually alone in including the cash register in the same elevated category.  Munger offers these words to sum up the life's work of the leading purveyor of the modern cash register: "So great was the contribution of Patterson's cash register to civilization, and so effectively did he improve the cash register and spread its use, that in the end, he probably deserved the epitaph chosen for the Roman poet Horace: 'I did not completely die'" (453).

Why does Munger offer such overflowing praise for such a commonplace item?  The answer lies in the principles of psychology.  Many people will steal if it's easy to do, and if there's little chance of being caught.  Once they start, though, a number of psychological traits will kick in and make it nearly impossible to stop: operant conditioning (people will repeat what's worked in the past), incentive-caused bias (people often genuinely believe that what's best for them is also what's best for others) and social proof (people tend to ape what other people are doing) will combine in a "lollapalooza effect" and thievery will spiral out of control.  The cash register nips much of this in the bud, to society's great advantage. 

This is just one of the many original, profound and tantalizing observations that can be found in Poor Charlie's Almanack: The Wit and Wisdom of Charles T. Munger, in Peter Kaufman's expanded third edition.  Munger is Berkshire Hathaway's long-serving Vice Chairman, and has been Warren Buffett's friend and business partner for many decades.  The book’s familiar-sounding title alludes to Poor Richard's Almanack, Ben Franklin’s famous autobiography.  Munger not only reveres Franklin, but has actively sought to emulate him.  Most would blush at the thought of modeling their lives on one of the great figures of the Enlightenment, but Munger's biography bears striking resemblances to Franklin’s. 

Munger, not just another brick in the wall, is a self-taught polymath, and can speak with authority on a staggering range of topics, just as Franklin did.  Both men became wildly rich through business in the first half of their lives, but devoted the latter half to philanthropy and other social and political causes.  And Munger is enough of a Renaissance man that he designed, built and paid for a large catamaran, just for fun, and he runs Good Samaritan Hospital in Los Angeles out of a sense of civil service.

Munger's most important contribution as a thinker is his multidisciplinary "latticework" of mental models that he uses to solve all kinds of complex problems.  He argues that this is a way of avoiding "man with a hammer syndrome," an allusion to the proverb, "To a man with a hammer, every problem looks like a nail."  He estimates that there are about one hundred powerful ideas, mostly drawn from 100-level university courses, that people should learn.  These ideas include ecosystems and synthesis from biology, backups and redundancy from engineering, probability and compound interest from mathematics, tipping points from physics and chemistry, tradeoffs and opportunity costs from economics, biases and heuristics from psychology, and so on.

Once a person's gained an understanding of the models, it becomes easy to draw parallels and analogies between them.  To cite a few of Munger’s favorite examples: interpreting an economy as a biological ecosystem, where occupying a specialized niche can offer great advantages; how the concept of "social proof" from psychology, the tendency to “ape” other people, can enhance economies of scale in business; economics borrowing from biology the "Tragedy of the commons" concept, which is a malevolent "invisible foot" to Adam Smith's benevolent "invisible hand"; and law schools applying game theory from economics to understand how competition works.  If economists made more efforts to synthesize a range of ideas, Munger contends, they wouldn't be so stumped about Japan's prolonged period of economic stagnation.  For his part, he believes that cultural characteristics and social psychology offer part of the explanation.

Munger is well aware, however, that it's possible to take even a great idea too far, and warns against borrowing indiscriminately, which has led to literature departments importing bad ideas from Freud, and business schools adopting a rigid adherence to "efficient market" hypothesis.  Devoted believers in efficient market theory arrived at a false conclusion by wanting to make economics more robust, like math or physics, than it actually is.  Markets are mostly efficient, most of the time, but the difference between mostly efficient and always efficient is vast.

Munger supplements the "Big Ideas" with a few critical rules.  For example, he often quotes Jacobi, the Prussian Mathematician, who insisted, "Invert, always invert."  In other words, some problems are best - or only - solved backwards, and some of his wisest advice is what not to do.  Accordingly, Munger once delivered a commencement speech that offered advice on what to do to achieve a miserable life, including being resentful of others, being unreliable, and refusing to learn from other people's mistakes.  Munger argues that Charles Darwin, one of the most important thinkers of all time, was merely above average in intelligence, but by avoiding bad habits and destructive behaviors, was able to make an enduring contribution to humanity.

Using a few of the powerful concepts from his multi-disciplinary approach, Munger offers a thought experiment in his fourth talk that essentially reverse-engineers Coca-Cola's astounding long-term success, explaining it using ideas such as Pavlovian conditioning and association, the biological facts of human nature resulting from evolution, using mathematical inversion to identify what not to do and avoid pitfalls.  These (and other) ideas underpin and complement more familiar concepts such as Coke's powerful brand and far-reaching distribution system.  The talk is difficult and bound to be misunderstood by many, but well worth reading anyway.

Munger can apply a striking array of ideas and concepts, but he is particularly insightful in the field of psychology.  Behavioral economics and neuroeconomics are deservedly flourishing fields, but Munger was using - and preaching about - the very same ideas long before almost anybody else was.  Munger argues that the psychological quirks are so important that wise people should write them out so they work through them checklist-style to solve difficult problems.  Pay particular note, Munger urges, to cases where several different psychological forces are working in the same direction. 

For Munger, mastering the theories that underpin psychology was no idle pursuit: he did it to "acquire capital and independence faster and better assist everything I loved" (444).  In the book's astonishing eleventh talk, Munger lists and explains 25 psychological tendencies that are generally useful, but often have unwanted side-effects that distort decision-making.  Munger goes beyond just citing psychology's best ideas; he also breaks new ground.  For example, he has long warned of what he calls "incentive-caused bias," which some belated economists are now dubbing "self-serving bias."  Munger had them beat by decades. 

On top of the psychological ideas that are all his own, Munger offers novel perspectives on others; he insists that anecdotally obvious forces such as envy and jealousy be included in the canon of psychological ideas; and he puts much greater emphasis on some of the widely-known ones than most people do, such as the overwhelming power of denial.  Munger's conclusions are deeply insightful, in part because they are often rooted in biology, a field that all of the social sciences have much to gain from.

Munger is refreshingly difficult to predict or pin down.  He proudly identifies himself as a Republican, and shares with his GOP party-mates a deep skepticism of Democrats; he has distaste for "pot-smoking journalism students"; and he's distinctly unsympathetic towards the less fortunate.  On the other hand, Munger is a staunch advocate for a woman's right to choose, having provided legal, monetary and diplomatic support to the cause; he believes that his taxes are too low; and he regards a "Drill, baby, drill" approach to oil and gas development as folly, not from a fear of global warming, but due to the value, scarcity and lack of close substitutes for those hydrocarbons.

Munger and his ideas are not to everyone's taste.  People who know him report that he is judgmental, self-righteous and arrogant.  Indeed, in one speech, he laments that a recurring problem he's faced because of his unusually high intelligence is the risk of offending bosses and experts who know less than he does about their own area of specialization.  Moreover, he has a staunch Aristocratic mindset, viewing the most eminent members of society - an exulted group that he certainly includes himself in - as superior and deserving of outsized wealth and influence, though not without duties. 

But being a snob can be a helpful trait in an investor, and it comes as no great surprise that Munger's major effect on Buffett was to move him away from investing in mediocre businesses selling at a cheap price, toward excellent businesses, even if they're selling at only a decent price.  And it was partly Munger's hard-to-please mentality that led him to prophesize disaster years before the crash of 2008-09: "I'd be amazed if we don't have some kind of significant [derivatives-related] blowup in the next five to ten years" (127).  He was among only a handful of major figures to say so, but few investors and fewer policy-makers listened, sadly.

Given Munger's dazzling intelligence and rich body of experience, it's easy to overlook Peter Kaufman's superb accomplishment as an editor.  Simply collecting Munger's thoughts, speeches, writings and other output would've been well worth the effort.  But this beautiful, coffee table-sized book has everything: a biography of Munger; a rich trove of photos and illustrations, as well as articles by and about him; brief commentaries from Munger's children, friends, colleagues, and fellow investors, including Buffett, Whitney Tilson and Bill Gross; and an array of book recommendations from Munger's long life as a devoted reader.  Kaufman also offers insightful commentary, and articulates Munger's musings in a comprehensible way.  Anybody searching for wisdom has much to gain from reading and rereading this book; but for investors this very fine work is an absolute must.

Here is a multi-disciplnary reading of Steve Jobs' life and work.

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.

ATP Oil and Gas - Exploration Success in Israel

Frazzled shareholders of ATP Oil and Gas received good news Monday, as the company announced success at its Shimshon well in offshore Israel.  The press release wasn't long on details, but the company discovered natural gas as hoped for.  Natural gas is a regional market, and the European and Asian markets currently offer significantly higher prices than the depressed North American one. 

The exploratory drilling represented a cheap, high-upside call option for the company.  Indeed, management has suggested that success in the Mediterranean has the potential to double the company's reserves, which are already strikingly large and valuable compared to its market capitalization.

It's unclear at this point how and when the cash-strapped company will proceed with developing its newfound asset, but more color will come in the third quarter, the company said.  However, since a portion of the company's liquidity is tied to the value of its reserves, it may mean added access to cash in the not-too-distant future.

If the company is able to successfully complete its Telemark workovers (they pledged to do so before June 30th, and, not for the first time, have failed to deliver on time) and its crucial Clipper wells, then the company is only suffering from a short-term liquidity crunch.  If not, there are fatal threats to its long-term solvency, though as long as they remain current on their interest payments, not until 2015.

In short, this was much needed good news, but white-knuckled shareholders are impatiently waiting for more of the same from Telemark in the coming days.

Disclosure: The author was long ATP options at the time this article was published.

My original write-up on ATP Oil and Gas 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.

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.

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.