Sears seems to be Eddie Lampert’s Waterloo
LNG bunkering’s time still has yet to come
An interesting reply to John Hempton’s post “When to average down”
Good overview about the current state of the mechanical watch market
Sears seems to be Eddie Lampert’s Waterloo
LNG bunkering’s time still has yet to come
An interesting reply to John Hempton’s post “When to average down”
Good overview about the current state of the mechanical watch market
Following the E.On discussion, I really asked myself if it was such a good idea to invest into Greenlight Re.
My argument was as follows:
After the E.On discussion however, I recognized the follwoing: Whenever I looked at a stock that Einhorn bought (Delta Lloyd, AerCap, SunEdison, Consol, E.on), I never understood why he did it or I thought it was not a good idea. Even if I look at his 20 bigest disclosed positions, I don’t find any stock that I would buy on my own:
APPLE INC AAPL US
GENERAL MOTORS CO GM US
ISS A/S ISS DC
CHICAGO BRIDGE & IRON CO NV CBI US
TIME WARNER INC TWX US
MICHAEL KORS HOLDINGS LTD KORS US
AERCAP HOLDINGS NV AER US
CONSOL ENERGY INC CNX US
ARKEMA AKE FP
AECOM ACM US
ON SEMICONDUCTOR CORP ON US
BANK OF NEW YORK MELLON COR BK US
TAKE-TWO INTERACTIVE SOFTWR TTWO US
GREEN BRICK PARTNERS INC GRBK US
MICRON TECHNOLOGY INC MU US
MARKET VECTORS GOLD MINERS GDX US
VOYA FINANCIAL INC VOYA US
LIBERTY GLOBAL PLC-SERIES C LBTYK US
DILLARDS INC-CL A DDS US
APPLIED MATERIALS INC AMAT US
That in effect lead me to the conclusion that I am most likely the wrong kind of shareholder for Greenlight Re. If things go really bad, I am not sure if I would have enough trust to keep the position or if I would get really nervous because I could not identify with the manager.
Secondly, I honestly don’t have much insight, how Einhorn generated his fantastic past track record.
Together with not liking his long position, I think it was a mistake to invest in Greenlight and I sold my stocks as mentioned in the comments at around 18,45 USD per share with a tiny profit of around +2,5%.
It could well be that Greenlight maybe has a spectacular 2016 but as I have mentioned above, one should not allocate money to someone where you don’t understand what that manager is doing. Conviction is important to withstand all kind of behavioural traps in investing.
Finally, I am not sure if there could be some isues on the Reinsurance side. AIG surpisingly disclosed a pretty massive reserve strengtening for Q4 and it looks like that this is mostly “long tail” exposure from long ago which is also the “bread and butter” business of Greenlight Re.
Following the market turmoil, I began to establish a first (2%) position in Handelsbanken. Purchase price was on average ~98 SEK per share. Valuation wise they are now at a level where I would expect to earn around 16-17% p.a. long term which looks atractive to me despite potential short term head winds.
I plan to increase this to a full position over the next months. I funded this position by selling some of the HT1 bonds, as I want to keep some cash (~10%) in order to be flexible if some of my watch list shares become really cheap.
Bill Ackman came out with his Q4 letter to investors just a few days ago. His results were similarily bad than Einhorn’s with -20,5% after fees for 2015.
There was already good coverage on his letter for instance from Matt Levine.
My 2 cents on this:
On a personal level, I do think there might be already TOO MANY activists. Many of them only care for short term payouts which, in many cases, might not be benefitial for long term share holders.
All in all, if I would have money invested with Ackman, I would really ask myself if I would trust a guy who only blames others for his misfortunes.
As this has turned out to be a very long post, a quick “Executive Summary”:
David Einhorn has published that German utility E.ON is one of his major new long positions. Based on what I have written in the past about E.On, I do think his summary investment rational has some serious flaws, mainly:
- buying management’s “spin” that the recent share price decline was only caused by uncertainties about nuclear provisions
- assuming a quick and very benefitial (for E.ON) solution for nuclear liabilities
To me it looks like that he tries to come up with some short term, rather risky “bets” in order to make good on his horrible 2015 performance as quickly as possible.
As a new shareholder in Greenlight Re I have to seriously rethink if I want to stay invested, however as a German tax payer I might also be biased in this case.
Greenlight Re is an interesting special situation in my opinion combining 2 bets in one stock:
1. It is a bet that David Einhorn will come back after his worst year ever and 4 years of underperformance
2. Greenlight Re, the Reinsurance company whose investments he manages “mean reverts” at least closer to its historical price book ratio.
This “bet” should be relatively uncorrelated to the overall market and due to the construction of the investment mandate, Einhorn can charge only half of the performance fee for some time.
Disclaimer: This is not investment advise. DO YOUR OWN RESEARCH !!!
Just to be clear: I have nothing personally against David Einhorn. I am just wondering how he comes up with his underlying valuation assumptions these days.
Now I came across his latest pitch for Consol Energy this week. This is the slide which explains the value of the coal business:
Without going into the other details, the question here is of course: How the hell did he come up with a WACC (Weighted Average Cost of Capital) of 8,4% ?
The WACC is supposed to be the blended total cost of capital of a company, including both, debt and equity. For Consol Energy however the obvious problem is the following: Their bonds are trading at a level of 12-15% p.a. Even if we us an after-tax figure of maybe 8-10%, even the after-tax cost of debt is higher than the assumed WACC.
As the cost of equity has to be higher than senior debt (it is more risky), there is no way in ending up with a WACC of 8,4%. Maybe some of my readers can help me out if I am missing here something, but I am pretty sure that 8,4% is not the right number for Consol’s cost of capital. He uses the same WACC later for the shale gas part of the company, so it is certainly not a typo:
On his website he then explains how they (or his intern) came up with the WACC (slide “A-1”):
The real joke however is to be found a little bit below:
Edit: Now that I know that it was meant as a joke it reads somehow different 😉
So he somehow believes that his WACC is actually conservative.
Let’s look at some “real world” data. This is the overview of Consol’s currently outstanding bonds:
The average yield based on outstanding amount of Consol’s bonds is 14,5%, a full 11% (or 1.100 basis points) higher than in Einhorn’s calculation. As I have said above, the cost of equity has to be higher than the cost of debt as thee is no protection to the downside. So if we use Einhorn’s quity risk premium of around 6%, we would get cost of equity of around 20,5%.
Based on Einhorn’s weighting, we would get a WACC of (20,5%*0,75) + (15,5%*0,65*0,25)= 17,73%, roughly speaking double the charge that Einhorn uses. You might say this is conservative but in effect it is just realistic and based on current market prices.
Even at issuance, Consol’s cheapest bond had a 5,875% coupon, far above the assumed 3,5%, so it is not even a question of current market dislocation.
Either Einhorn assumes implicitly that cost of capital goes down dramatically or he has some “secret” that I don’t know. If I look at Einhorn’s last pitches, especially AerCap, SunEdison and Consol, there seems to be a common theme: He is always pitching capital-intensive companies with significant debt where he assumes pretty low cost of capital in order to show upside.
So what he seems to do these days is effectively betting on low funding costs which, at least for SunEdison and Consol didn’t work out at all.
In my opinion, this has nothing to do with value investing. Value investing requires to make really conservative assumptions to make sure that the downside is well protected as first priority. For those leveraged, capital-intensive businesses however, the risk that you will get seriously diluted as shareholder in those cases is significant, there is no margin of safety. On the other hand I somehow admire his Chupza. Standing in front of a lot of people who paid significant fees to hear the “Hedge Fund honchos” speak and pitching such a weak case with unrealistic assumptions is brave.
Of course a stock like Consol can always go up significantly after dropping -75% year to date, but the underlying analysis is really flawed. I would actually like to ask him if he really believes in those assumptions or if he just didn’t pay any attention to the details. This would be really interesting.
Maybe a final word on this: I am always criticising David Einhorn on his assumptions. Which is easy because he actually is very transparent about them. Many other Hedge Fund managers just tell nice stories. I am pretty sure that in many cases the assumptions behind those cases are not much better.
SunEdison, a US based renewable energy company popped up 2 times on my radar screen. Once a year ago as one of David Einhorn’s top picks and last week as one of the very few published long investments of John Hempton at Bronte.
I try to sum up Einhorn’s 2014 thesis in four bullet points:
– Solar energy is competetive, strong growth almost guaranteed
– SUNE has a moat and will grow strongly by maintaining its margins
– extra value is created via the “YieldCo” subsidiary
– investors don’t understand the company especially the fact that most of the debt is “non-recourse”
From Einhorn’s slide deck:
As an experienced project developer, SUNE’s financial, legal, and due diligence expertise gives it a competitive moat. It has opened offices in the most attractive international markets several years before anyone else, giving it a first mover edge and unique geographic diversity in an industry that faces capricious governments, currency fluctuations, sovereign risk and competition.
Well, now it is pretty easy to point out that this thesis might have some flaws after the stock cratered in the last weeks:
Let’ just look at the annual report where SUNE reports on competition:
Competition. The solar power market in general competes with conventional fossil fuels supplied by utilities and other sources of renewable energy such as wind, hydro, biomass, concentrated solar power and emerging distributed generation technologies such as micro-turbines and fuel cells. Furthermore, the market for solar electric power technologies is competitive and continually evolving. We believe our major competitors in the renewable energy services provider market include E.On, Enel, NextEra, NRG, SunPower Corporation, First Solar, Inc., JUWI Solar Gmbh and Solar City. We may also face competition from polysilicon solar wafer and module suppliers, who may develop solar energy system projects internally that compete with our product and service offerings, or who may enter into strategic relationships with or acquire other existing solar power system providers.
We also compete to obtain limited government funding, subsidies or credits. In the large-scale on-grid solar power systems market, we face direct competition from a number of companies, including some utilities and construction companies that have expanded into the renewable sector. In addition, we will occasionally compete with distributed generation equipment suppliers.
We generally compete on the basis of the price of electricity we can offer to our customers; our experience in installing high quality solar energy systems that are generally free from system interruption and that preserve the integrity of our customers’ properties; our continuing long-term solar services (operations and maintenance services) and the scope of our system monitoring and control services; quality and reliability; and our ability to serve customers in multiple jurisdictions.
If you compete mainly on price, then there is obviously not much of a moat. There are no network effects, they don’t have any patents and clients don’t care about the brand of a solar project company. In contrast, a strongly growing markets attracts many new entrants which will drive down margins especially if it is relatively easy to enter the market. or even if there would be an “econimies of scale advantage”, in a strongly growing market this is not worth much
Germany is here maybe already some years further in the experience curve and one learning here was that there wasn’t any first mover advantage. In contrast, many of the first movers made some real mistakes like contracting solar modules for fixed prices and were then wiped off by the followers who bought cheaper.
If you look at SunEdisons investor presentation, you don’t see any GAAP numbers, only adjusted EBITDAs and self created metrics like MW and GW delivered etc. The reason is clear: GAAP numbers look awfull, both earnings and cashflows at all levels. The company is using boatloads of money under GAAP reporting.
Overall, the accounts are pretty much incomprehensible not only on the financing side but also cash flow wise. So non-recourse debt sounds great but without earnings it will be a quite difficult investment case.
The YieldCo – TerraForm Power
TerraForm Power is a consolidated subsidiary of SUNE but has a stock listing and minority shareholders. The sole function of TerraFrom power is to buy the projects from SUNE, leverage them up ~4:1 or 5:1, hold them and pay out dividends. The stock price got hit hard along SUNE as this chart shows:
However according to Einhorn the participation is extremely valuable due to 2 reasons:
1. A Yieldco structure is value enhancing per se as Yieldco investor require much lower returns on investment as stock investors
2. Terraform and SUNE have a structure in place where SUNE retains much of the upside of the YieldCo, so the worth to SUNE is much higher than the market value of the shares
Einhorn makes some remarkable comments in his presentation, but I was struck mostly by this one:
In the recent sell‐off, Terraform’s shares declined with the oil and gas MLPs. Because most MLPs pay out cash flows from depleting oil and gas reserves that need to be replaced with new wells, these companies need continued access to cheap capital just to sustain their dividends. Terraform doesn’t face that risk because solar assets don’t deplete. So Terraform will only raise capital for growth.
Well, this is clearly wrong. Of course do Solar panels deplete. They seem to deplete clearly slower than oilwells but the problem is that there are not that many old solar panel installed to actually get statistical relevant numbers. Some studies show that there is a relatively high loss of power in the beginning (~5%) and then a depletion of capacity of around 1% per year. Additionally, most of the funding and the electricity take-off agreements have to be renewed at some point in time which includes some significant “roll over” risk ithin the YieldCos.
Another thing that struck me is the fact that both, SUNE and Einhorn assume ~8,5% p.a. unlevered return on their renewable assets going forward which then can be levered up nicely even if you have to pay 6% interest on your bonds. I don’t really know the US market, but assuming such a yield in Europe would be completely unrealistic. Unlevered yields for renewable energy projects are at 4-6% p.a. max and you can only lever them up with “low cost” leverage for instance pension or insurance liabilities, it doesn’t really work with long term more expensive “subordinated” capital as many companies have found out the hard way.
Maybe the US market is less competitive to allow such returns ? I find that hard to believe. Just by chance I have been involved in some uS wind projects and the returns are nowhere near 8% unlevered but rather similar to European yields.
Another thing which is different to European projects: In Europe, you don’t have specific credit risk in the projects as the electricity has to be taken off from the grid, which means that basically all grid user guarantee your return. SunEdison’sproject contain undisclosed credit risks because if the client default there will be no backstop.
That leads to the question: Who on earth is actually buying into those YieldCos ? In TerraForm’s case any upside is capped and equity holders are fully exposed to any problems that could show up like increasing interest rates, defaults of off-takers, debt roll risk etc. So who is prepared to take equity like risk but accepting bond like returns ? I do know but my guess is that many yield starved private investors will most likely not care about the risks as long as they get a “juicy” dividend. In Germany something similar but on a lower scale happened. a lot of the renewable companies financed themselves with “participation rights” and promises of high dividends but most big cases ended in spectacular failures. I covered some here for instance
To shorten this: Yes, at the moment the Yieldco structure could actually generate some value because for the time being there seem to be enough stupid investors out there who buy something with equity risk in exchange for bond like returns. But this could go away quickly especially if some of them blow up spectacularily. It’s the same old reason why people on Wallstreet earn so much: Pretending that repackaging an asset increases its value.
Although the complicated financing structure attracted me to the stock in the first place, based on what I have written above I don’t think it’s worth the time to dig deeper. One thing that John Hemption seems to have missed in his post is the fact SUNE has implemented a margin loan with TerraForm Power shares as collateral. Such a strcuture alone for me already indicats that either those guys don’t know what the are doing or that they are really desperate.
In such a case the only “safe place” in the capital structure is within the senior secured paper, everything else in my opinion is more a gamble than a value investment.
At the first glance Sun Edison looks interesting. You can buy into a (still) strongly growing company at around 1/3 of the price David Einhorn paid a year ago. From my point of view however the business relies on two fundamental assumptions to perform as planned:
– the ability to continously source renewable energy projects with really high yields (“risk free” plus 6% or so)
– enough stupid investors who buy into YieldCos with equity like risks and bond like returns to subsidize the development company
If Germany as one of the renewable power pioneer markets is any indication, both assumptions will not hold for very long. In Germany’s case, the yield for the projects went down very quickly especially after government subsidies were reduced and the “yield investors” got fleeced massively as a consequence.
Clearly, in the short run SUNE and TERP could make massive jumps up and down in price but mid- to long term I don’t think that they will be great investments.
P.S.: It might look like I want to bash David Einhorn, as this is already the third time that I strongly disaggree with him after Delta Lloyd and Aercap. But on the contrary, i do still think that he s one of the best investors in the hedge fund area, he just had some bad luck and a lot of money to manage which makes things difficult.
So after my first look into David Einhorn’s long pick AerCap last week, I want to follow up with some more detailed analyis in a second step.
By the way, a big “thank you” for all the qualified comments and Emails I got already after the first post, that’s the best return on investment on a blog post I can get !!!
The book value story growth
This was for me one of the core slides of Einhorn’s deck:
I mean you don’t have to be a genius to understand this: A company which trades near book value and compounds 20% p.a. is pretty much a no brainer. However, if I look at the developement of book values for financial companies, I always look at both, stated and tangible book value per share.
In AerCap’s case, the comparison looks interesting:
|BV per share||TBV share|
This table shows two things: Before the ILFC transaction, stated book values and tangible book values were pretty much the same and compounding around 13% p.a. Still pretty good but clearly not 20%. In 2014 however, with the ILFC deal something interesting happened: The book value per share doubled but tangible book value dropped.
The ILFC deal
So this is the right time to look into the ILFC deal. The two main questions for me are:
a) why did the book value per share increase so much ?
b) why did tangible book value per share actually decrease ?
This is how AerCap presents what and how they paid for ILFC:
So AerCap paid the majority of the purchase with own shares, 97,56 mn shares valued at 46,49 USD. Issuing new shares always has an impact on book value per share if the issue price is different from the book value. Let’s look at an example:
We have a company which has issued 100 Shares at 50 EUR book value per share and 100 EUR market value (P/B =2). So the total market value is 10.000, total book value is 5000. If the company now issues another 100 Shares at 100 EUR market value, we have 200 shares outstanding and 5000+10000 = 15.000 EUR total book value. Divided by 200 stocks we now have 75 EUR book value per share or a 50% increase in book value per share for the old shareholders. So issuing shares above book value increases book value per share automatically.
In AerCap’s case, it worked more or less the same way: AerCap had ~113 mn shares outstanding with a book value of around 21,30 USD per share. So issuing 97,56 mn share at a steep premium at 46,49 of course increased book value per share dramatically. The transaction alone would have increased the book value to ((113*21,30)+(97,56*46,49))/(113+97,56)= 32,97 USD per share or an increase of ~50%.
So how is this to be interpreted ? Well, clearly it was a smart move from AerCaps management to pay with its owns shares at such a nice price. On the other hand, one should clearly not mistake this a a recurring kind of thing. I would not use the historic 20% p.a. increase in ROE as expectation for the future but rather something like 13% or so in the past.
After looking into how much and in what form AerCap was paying, let’s look now what they actually got:
Yes, they got a lot of planes and debt. Interestingly they assumed more debt than book value of the planes. Altogether they did get a lot of intangible assets. All in, AerCap bought 4,6 bn intangibles which is around 80 mn more than equity created through the new shares. So at the end of the day, one could argue that the new shares have been exchanged more or less 1:1 against intangible assets.
The largest part of this is a 4 bn USD position called “Maintenance rights intangible” which for me is something new. This is what they say in their 20-F filing:
Maintenance rights intangible and lease premium, net
The maintenance rights intangible asset arose from the application of the acquisition method of accounting to aircraft and leases which were acquired in the ILFC Transaction, and represented the fair value of our contractual aircraft return rights under our leases at the Closing Date. The maintenance rights intangible asset represents the fair value of our contractual aircraft return right under our leases to receive the aircraft in a specified maintenance condition at the end of the lease (EOL contracts) or our right to an aircraft in better maintenance condition by virtue of our obligation to contribute towards the cost of the
maintenance events performed by the lessee either through reimbursement of maintenance deposit rents held (MR contracts), or through a lessor contribution to the lessee. The maintenance rights intangible arose from the application of the acquisition method of accounting to aircraft and leases which were acquired in the ILFC Transaction, and represented the fair value of our contractual aircraft return rights under our leases at the Closing Date. The maintenance rights represented the difference between the specified maintenance return condition in our leases and the actual physical condition of our aircraft at the Closing Date.
For EOL contracts, maintenance rights expense is recognized upon lease termination, to the extent the lease end cash compensation paid to us is less than the maintenance rights intangible asset. Maintenance rights expense is included in Leasing expenses in our Consolidated Income Statement. To the extent the lease end cash compensation paid to us is more than the maintenance rights intangible asset, revenue is recognized in Lease revenue in our Consolidated Income Statement, upon lease termination. For MR contracts, maintenance rights expense is recognized at the time the lessee provides us with an invoice for reimbursement relating to the cost of a qualifying maintenance event that relates to pre-acquisition usage.
The lease premium represents the value of an acquired lease where the contractual rent payments are above the market rate. We amortize the lease premium on a straight-line bases over the term of the lease as a reduction of Lease revenue.
This sounds quite complicated and for some reason part of the sentences seem to have been duplicated. If I understand correctly, they assume that the underlying value of the aircraft is higher than the book value of the acquired planes. To be honest: I do not have any clue if this is justified or not.
However, as those intangibles are significant (more than 50% of book value), the case gets a lot less interesting for me. Intangibles created via M&A activity are in my experience always difficult, especially if it is esoteric stuff like this. It’s also a big change to the past of AerCap. Historically, they were carrying very little intangibles.
Funding cost & ROE
This was Einhorn’s prospective ROE calculation:
One of the key assumptions is a 3% funding cost. So let’s do a reality check and look at the expected pricing of AerCaps new bond issue. This is from Bloomberg:
Aercap $750m TLB Talk L+275, 99.75, 0.75%; Due April 30
By Krista Giovacco
(Bloomberg) — Commits due April 30 by 12pm ET.
Borrower: Flying Fortress Holdings LLC, a subsidiary of AerCap Holdings and International Lease Finance Corp., largest independent aircraft lessor
$750m TLB due 2020 (5 yr extended)
Price Talk: L+275
Libor Floor: 0.75%
Call: 101 SC (6 mos)
Fin. Covenants: Max LTV test
Existing Ratings: Ba2/BB+ (corp.); Ba1/BBB-, RR2 (TLB)
So AerCap is funding at a spread of 2,75% vs. LIBOR. With the 10 year USD LIBOR at 2,00%, funding would be way more expensive than the 3% assumed by Einhorn. Maybe the fund floating rate, but then the whole company would rather be a bet against rising interest rates than anything else. On a “like for like” basis without structural interest rate risk, I don’t think AerCap will generate a double-digit ROE at current spreads.
Business case & competitive environment
Within the comments of the first post, some people argued that the company is not a financing company but that the access to Aircraft is the value driver. Buying cheap aircraft from manufacturers and then selling (or leasing) them with a mark-up to clients then looks like some kind of Aircraft trading business.
For me however there is one big problem with such a business model. Retailing or wholesaling any merchandise is then most attractive as a business when 3 criteria are met:
– there are a lot of suppliers
– there are a lot of clients
– you can create a competitive advantage via physical distribution networks
In AerCap’s case, the biggest problem is clearly that there are not that many suppliers but only 2, Boeing and Airbus. Both don’t have much incentive to let any intermediary become too large so they will most likely encourage competition between Aircraft buyers.
Secondly, as far as I understand, there is no physical distribution network etc. behind AerCap’s business. So entering the market and competing with AerCap in the future doesn’t look so difficult for anyone with access to cheap capital.
Clearly, as in any opaque trading business, an extremely smart trader can always make money but it is important to understand that at least in my understanding there are no LONG TERM competitive advantages besides the purchase order flow from ILFC.
That the barrier to entry the business is not that high is proven by no other than Steven Udvar-Hazy the initial founder of ILFC and his new company Air Lease.
IPO’ed in 2010 and now the company is already a 4 bn USD market company 5 years later. Interestingly, AIG sued Air Lease in 2012 because they
were able “to effectively steal a business,” and reap a windfall at the expense of ILFC, the world’s second-largest aircraft lessor by fleet size. It described how some employees, while still working at ILFC, downloaded confidential files and allegedly diverted deals with certain ILFC customers to Air Lease, before leaving to join that firm. The companies are in the business of buying aircraft and leasing them to commercial airlines all over the world.
So to me it’s not clear what AerCap actually bought. It seems the “secret sauce” of ILFC seems to have been transferred to competitor Air Lease already. Interestingly, the lawsuit was settled a few days ago at a sum of 72 mn USD. I found that quote from Udvar-Hazy interesting:
“I want to make it clear that there is no secret sauce in the aircraft leasing business,” Hazy told analysts on a conference call. “ALC’s success is a result of a strong management team with extensive experience and solid industry relationships.”
My problem with AerCap is the following: The financial part of the company, which I feel that I can judge to a certain extent, does not look attractive but rather risky to me. The Aircraft “buying and trading” segment on the other hand seems to be the more attractive part but for me too hard to judge in a reasonable way.
So for the time being, this is clearly not an investment for me. To look further into AerCap, two things need to happen: First they need to regain their investment grade rating and funding cost will need to drop to the 3% that Einhorn is assuming and secondly, there should be a clear impact on the share price from a potential sale from AIG.
In the current market environment clearly anything can happen and a multiple expansion could bring nice profits but personally, in a direct comparison I prefer the LLoyd’s case.