Holders of Dendreon Bonds

According to 13-Fs, as of 6/30 the largest holders were:

• Deerfield Management, $223 million face [36% of outstanding]
• Empyrean Capital Partners, $97 million
• Partner Fund Management, $68 million
• Aristeia Capital, $66 million
• Waterstone Capital Management, $35 million
• Wolverine Asset Management, $30 million

Those six own $520 million worth, which is 84% of the whole issue.

Deerfield claims to manage $5 billion in public and private equity funds. The Dendreon bonds are actually the largest investment on their 13F. They must be really bullish on Provenge, and they don't own any common stock. They may want to wind up owning the company in a restructuring. I would imagine they will be leading the eventual negotiations about how much of the company bondholders will get.

Empyrean manages several billion, and their 13F shows all the classic long/short hedge fund stocks like Allergan and Yahoo. They also own Quicksilver Resources, a terrible energy name with bonds now trading at 25 whose stock has gotten crushed. They own so much DNDN debt that a exchange into equity would probably be the best way out of the position, if they wanted to.

Partner seems like yet another $5 billion dollar fund that owns the typical big fund stocks too (13F): Google, Allergan, Priceline, Netflix, Microsoft, and lots of healthcare/pharma names. This is a tiny position for them but a pretty big piece of the DNDN issue.

Aristeia was in the Genco Shipping trade. They do capital structure arbitrage. They own (13f) other distressed names like VRS, MCP, but also momentum like TSLA.

It ought to be possible for the company to get these holders to agree to take over the company through a distressed debt exchange.

From Walter Energy Inc Earnings Q3 2014 Earnings Call $WLT

From the Q3 conference call this week:

Q: Timna Beth Tanners: I just wanted to ask two questions. One is just a clarification on something you said earlier. I just wanted to make sure I heard you right, that you're still looking for ways to cut SG&A and that you're still considering possible debt for equity swaps. Is that - was that what I heard?

A: William Harvey: Yes.

A: Walter J. Scheller: Well, we're always looking at ways to cut SG&A, and we're not going to stop at $70 million. We're going to continue to squeeze every penny out of that that we can squeeze out of it. And on the equity swaps I'll let...?

A: William Harvey: Yes. Yeah. No, you're right on both counts.

They have such a big interest burden:

"Prospectively, given our recent financing activities, our annual interest expense is expected to be roughly $310 million, of which $265 million is cash."

"Sears Has a Deal to Offer Its Shareholders" $SHLD

Good discussion of the new rights offering:

"Sears needs money. It is at the point where it can only raise that money on fairly embarrassing terms. The most natural provider of money on embarrassing terms is its CEO, but it's a little awkward to take money from your CEO on embarrassing terms, and anyway he drives a hard bargain. The only way to make that look OK is by offering the same embarrassing terms to everyone. And if not all of them are able to accept, because they're not natural holders of bonds and warrants, then so much the better. The CEO will step up. There's your deal."

Good Day For Silver Puts

This chart "looks like" it is going to about $10/oz which, coincidentally, is about the cash cost of silver.

The Probability Of Deflation Has Diminished?

The Fed said

"the Committee judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year"

Yeah right! Look at a chart of the 30 year yield (down almost 100 bps ytd) or of a commodity index like DBC. Deflation!

What this tells you is that their concern about deflation is situational, conditional. Deflation that threatens the big banks that own the Fed is bad. Deflation that squeezes the proles out of their assets and makes them renters is good.

The big banks have been recapitalized and the proles are making a bit too much money flipping paper [1,2]. Maybe the Fed thinks it's time to pull the rug out from under them?

Removing the inflationary supports in conjunction with a nonsensical propaganda statement is consistent with pulling the rug out. Is it consistent with anything else?

Remember I said four years ago that the Fed was throwing the deflation game? Silver and gold are both significantly lower than when I wrote that post.

The biggest consensus in the market today - by far and away - is that the Fed is just kidding around and will print at the first sign of weakness, and that the printing will take asset prices to new highs. People have staked everything on the conjunction of those two assumptions.

#Timestamp the Arrogant CEO of Cleveland-Cliffs Inc. $CLF

Sam D. Dubinsky: Great. Thanks. Thanks for taking my question. Just in Q3 looks like pricing was pretty good in the U.S., better than I thought based on where spot is. Was there any higher priced carryover tonnage from the first half? Just because I know there was some supply disruption that pushed H1 into Q3 a little bit? And then I have a couple follow ups.

C. Loureno Goncalves: Sam, I appreciate you saying thank you for taking your question, but I'm not going to answer your question, because you already knew everything about my company. You have a $4 price target and you think that we can't sell assets. So I'm going to take the next question. I'm not going to answer you. Next question, operator, please.

Get Out Of Dodge?

A correspondent writes in about "another liberal hypocrite. Do as we say, not as we do" from banana republic New York City:

"Mayor de Blasio's SUV caught on camera running two stop signs and speeding just days after he announced crackdown on dangerous driving"

Smart people I know are selling their California and New York real estate and getting out of Dodge. Gary North says:

"Lesson: if you can read a map and draw conclusions, you can do quite well in bad times."

People have a great deal of inertia in their affairs. But as Gary says, "the emigrant plans an escape route before his peers think there is anything seriously wrong".

"Miners Shovel Coal Into Flooded Market" $WLT

Miners are shoveling more metallurgical coal on to a global market already awash with the steelmaking commodity, delaying any recovery in prices that are at multiyear lows.[...]

BHP Billiton Ltd. became the latest company to unveil record output of metallurgical coal, after opening new mines planned years ago when prices of the commodity were at a peak. But the extra supply is far outpacing demand in countries such as China and Japan, which produce much of the world's steel. Miners' willingness to dig up more coal despite lower prices mirrors a similar push in iron-ore where miners are investing billions of dollars and running their operations harder in a bet that their enormous efficiencies of scale will allow them to profit. However, critics say the strategy risks creating a supply glut of each of the raw materials used to make steel that will take years to clear.[...]

The supply surge is weighing on prices, and forcing analysts to redraw their expectations of a recovery. Many companies with unprofitable mines are opting to wait out the downturn, rather than shuttering production and laying off staff. [...]

"We are forecasting a surplus again in coking coal in 2015," said Christopher LaFemina, an analyst at broker Jefferies who estimates the market oversupply will double to 20 million tons in 2015 from 10 million tons in 2014. Consequently, the potential for coal prices to rise "is likely to be much more limited than we had previously anticipated," he said.

Isn't the potential for coal prices to rise not just unlikely, but in fact more likely for prices to fall, if the size of the met coal surplus is going to increase next year?

The implications for high cost miners are so grim that many in the industry seem to prefer to hide their heads in the sand about what's coming.

Value Investors Obsessed With "Compounders", ROE; Don't Care About Liquidation Value Or Margin Of Safety

Young Money did a post called "Two great posts from Credit Bubble Stocks":

"I find this fascinating because it shows how much valuation standards can change over time. Today, a company is praised for earning a high return on equity (ROE). In Graham's time, companies were praised for having significant assets, even if reporting significant assets depressed their stated ROE."

I sent this to Oddball Stocks, who responded with a great comment:

"It seems the high ROE trend has been born out of the crash of 2008. I don't remember anyone talking about it before then. Now I see things all the time saying 'they earn 4% on equity so they're only worth 40% of book value'. Of course that's insane, someone could purchase them and unlock the value. Or new management could unlock the value.

It seems since the crisis investors have lost their imagination. We have investors believing that anything good will go on forever; these are the growth companies. A company doesn't grow to the sky. Wells Fargo isn't going to grow at 15% a year for decades, if they do in something like 15 years they will be 100% of the banking market in the US. The other are value investors who can't imagine a bad company changing. Things happen, management changes, people change, things change. Nothing is static, yet we live in this static market. It's weird."

I would summarize this by saying that "value" investors are currently obsessed with "compounders" (i.e. "quality" businesses with high returns on equity, and they don't care about liquidation value or margin of safety.

I'm not saying you can never make money buying a high margin, high ROE business at over five times book value, but that's not value investing as the style was traditionally known.

To me (and to Graham), value investing is buying a consistently profitable bank at 60% of book, or closed end muni funds when they are trading at historic discounts to NAV.

"Judges Feedback from FactSet Best Short Idea Contest"

From an email that Sum Zero sent out.

"Unless you’re looking at very small companies or you’re in a period of general market dislocation, you’re not dealing with neglect but instead taking a position on a controversial aspect of a business. Summarizing the available data from financials/presentations/CCs is 60-80% of the work; it basically puts you in an informed position as to what is controversial but it doesn’t provide an edge or advantage on the controversy. Said differently, getting to the point where you understand what is controversial is 60-80% of the work, and it is the easy part. You need to be analytical, but it doesn’t require discomfort or creativity."

Probably everyone in the business got this email, but kind of amusing to repost.

"Walter Energy Declares Quarterly Dividend" $WLT

From the geniuses at Walter Energy:

"Board of Directors has declared a regular quarterly dividend of $0.01 per common share"

This is a company with bonds yielding 43%.

Throttle-up as you crash the plane into the mountain.

"Drawn to Lost Causes, a Hedge Fund Seeks to Turn Them Around" $RSH $APP

Hilarious article about hedge fund "Standard General" and its investments in various dogs:

“Standard General made a bad investment. They made a mistake,” said Michael Pachter, an analyst at Wedbush Securities. “They’re throwing good money after bad.”

including Radio Shack.

Thoughts From A Correspondent On Living In A Declining Empire

A correspondent writes in:

One reason for the collapse of empires is that the knowledge needed for maintenance of the empire is closely held and actively suppressed because it is in the short-run interest of an oligarchy to suppress it. For example, only a small circle of the Russian Communist Party had access to economic reports. It was the same in China. It could be dangerous to have certain kinds of knowledge, and yet things could fall apart without that it being widely diffused in the right hands.

Our public discourse is choked with lies:

"you end up with an entire society in an hallucinatory state, and behaving like people who hallucinate will: we’ll respond to things that aren’t there, and fail to see the ones that are[...]" [link]

Things to do to compensate for these lies are to:

• Withdraw respect and consent.
• Get interested in epistemology, i.e., the study of how we know what we know.
• Listen for contradictions.
• Listen for admissions against interest.
• Be widely educated in science and technology so as to see contradictions between manipulative lies and well-established scientific principals.
• Throw your TV away.
• Cancel your newspaper.
• Turn your radio off, except for music.
• Watch for contradictions between manipulative lies and your own direct experience.
• Listen to a liar's story change as his motive's change.
• Depend on the life experience of smart old people who have no conflict of interest with you.
• Shun any news medium, person or definable interest group that you catch in a lie.
• Shorten your supply chains. The longer your supply chain, the bigger the proportion of people at the other end who don't care if you are dead
• Get as much of your food as possible from people you know. Grow the rest.
• Realize that medicine is a business that makes money by selling drugs and procedures. It is not your mom.
• Rely on plants, fatty acids, amino acids, vitamins and minerals for healing.
• Eat right and stay fit to stay well.
• Stay out of restaurants to get the best ingredients and the cook with the cleanest hands. 
• Avoid surgeons and hospitals.
• Avoid prescription drugs. Find natural substitutes
• Grow as much of your medicine as you can.
• Avoid depending on the truthfulness of strangers.
• Stay away from crowds to stay away from trouble. Use amenities in off hours.

In re: GT Advanced Technologies, Inc., et al.; RESPONSE OF DOW JONES & COMPANY, INC. TO RELIEF SOUGHT BY DEBTORS IN THEIR EMERGENCY MOTION FOR ENTRY OF ORDER, PURSUANT TO BANKRUPTCY CODE SECTION 107(B) AND BANKRUPTCY RULE 9018, AUTHORIZING FILING UNDER SEAL $GTAT

From the motion:

"Dow Jones & Company, Inc. (“Dow Jones”), publisher of The Wall Street Journal, Dow Jones Newswires, and a variety of other news and information publications, respectfully submits this response to the Debtors’ request (DN 92) to file an unredacted version of the Supplemental First Day Declaration of Daniel W. Squiller (the “Supplemental Declaration”) under seal, or in the alternative, to file the full document in the public docket. [...]

During an adjournment in the initial hearings on October 9, the courtroom was cleared to address this motion. Only the United States Trustee and counsel for Apple and the Debtors were permitted to participate. On information and belief, this closed hearing continued for at least twenty-five minutes. [...]

More than the Supplemental Declaration is at stake. Dow Jones is concerned that information submitted as the cases progress that touches in any way on Apple, or falls within the expansive terms of the confidentiality agreement (DN 92-3), will be subject to seal, redaction, or other restrictive terms. [...]"

Arguments:

• The Supplemental Declaration Does not Qualify for the Limited Exceptions to the Right of Public Access Described in 11 U.S.C. §107(b).
• Preventing Public Access to the Supplemental Declaration Would Also Run Afoul of Critical Constitutional Principles.
• In the Alternative to Full Disclosure of the Supplemental Declaration, the “Least Restrictive” Means of Balancing the Public’s Right of Access with the Limitations Described in Section 107(b)(1) is to Closely Redact the Document – Not to Seal it Entirely.
• The Court Should Also Release Any Transcripts and Recordings Made of the Closed Hearing Held on October 9, 2014.

Municipal Natural Gas Prepayment Deals

The second largest holding in the NAZ muni ETF is Citigroup Energy I: Salt Verde Prepay. Here's an article from 2008 about municipal natural gas prepayment deals:

A gas prepayment is a contract under which an agreed amount of discounted gas is supplied over a period that can range from 10-30 years. Crucially, the main difference between a typical commercial prepayment transaction and one involving a municipal utility or public agency is that the latter purchase is financed through the issuance of tax-exempt bonds.

"A public agency can issue such bonds and then use the proceeds to prepay for a specified, predetermined stream of natural gas," says Troy Black, managing director of financial products at BP in Houston. "The municipality passes the proceeds of the bond issuance by virtue of prepayment to a prepay supplier, which then has the obligation to deliver a steady stream of gas."

The article has a hilarious quote: "The market interest rate spreads are not currently conducive to meeting some of the economics that people became accustomed to by the middle of 2007"

Economist On Sustainability of Low Oil Prices

Article

"Demand for oilfield equipment and services has outstripped supply, which has also increased development costs. Even before the latest swoon in oil prices, overall costs had been outstripping revenues by 2-3% a year. The result is that nearly half of the projects the industry has under development will need oil prices greater than $120 a barrel to achieve positive cashflow."

Credit Spreads Suddenly Wider $HYG

This is a dramatic widening in credit spreads. And from the look of the chart, the trend in spreads is very bullish (wider).

That has a lot of implications. Mood shift. Flight away from risk to Treasuries. The LBO bid for companies falls or goes away entirely.

A correspondent writes in,

"I believe that most market observers have forgotten that in past rate cycles market driven rate increases always lead Fed increases. Here we have the junk bond market beginning the tightening well in advance of the Fed. Quality spreads will widen across the curve. Watch CDO issuance collapse as the risky tranches become hard to place. Watch for private equity deals to dry up. And what dry powder does that Fed have to stop it? Is the next QE going to purchase lower rated CDO tranches and junk bonds instead of treasuries and mortgages? Would a revived QE directed at treasuries do anything other than exacerbate the flight from junk and risk to safe and upwardly trending treasuries? This is how collapse starts as it moves from the fringes of the credit market toward the 'safe and secure' center."

Update on Ceres Global Ag Corp: Building The Northgate Commodity Logistics Hub $CRP

Press release:

"Ceres Global Ag Corp. (TSX: CRP) announces that it has received equity and debt financing proposals to advance the construction and development of the Northgate Commodity Logistics Centre. The major aspects of the proposals include: 1. an offering of rights to purchase common shares for gross proceeds of C$70 million. VN Capital Fund C, LP, a limited partnership controlled by the two principals of VN Capital Management, LLC, James Vanasek and Patrick Donnell Noone, and funds managed on behalf of Whitebox Advisors, LLC, have announced their intention to fully backstop the rights offering."

Ceres is up 40% since it was mentioned here in December 2011. Here's the current business description:

"a Grain Storage, Handling and Merchandising unit, anchored by its 100% ownership of Riverland Ag Corp., and a Commodity Logistics unit, containing its 25% interest in Stewart Southern Railway Inc. and its development of the Northgate, SK Commodity Logistics Centre.

Riverland Ag Corp. is a collection of nine (9) grain storage and handling assets in Minnesota, New York, and Ontario having aggregate storage capacity of approximately 47 million bushels. Riverland Ag also manages two facilities in Wyoming on behalf of its customer-owner. Stewart Southern Railway Inc. is a short-line railway with a range of 130 kilometres that operates in South-eastern Saskatchewan. The Northgate Commodity Logistics Centre is a proposed $96 million grain, oil and oilfield supplies transloading site being developed in conjunction with Riverland Ag and several potential energy company partners, connected to BNSF Railway."

The way you make money in grain storage is to buy grain, store it in your elevators, and sell it forward. In order to be profitable, that strategy requires the futures market to be in contango: future prices that are higher than the spot price. And in order for the market to be in contango, there needs to be a glut of the commodity. Basically, the grain storage facilities get paid the most when there is a lot of commodity to store, which makes sense.

When we wrote the 2011 post, corn and hard red spring wheat were both in backwardation - future prices lower than spot prices. That has changed and now corn and wheat are in contango. Dec 15 corn is 14% more expensive than Dec 14 and the wheat is 10% more expensive. There ought to be some money in storage now.

I don't know much about the grain storage business, but Ceres has 48mm bushels of capacity. I would think the economics are that you could buy and store say $160mm worth of corn and sell it a year later for $183mm, for $23 million in profit minus financing costs. But in their investor presentation, their 2014 EBITDA projection for the Riverland segment is $2.6mm. Of course, it's only recently developed that grains are in contango again.

The Stewart Southern Railway is a Bakken play. They own 25% of it, it does 40 railcars a day full of oil, $5.8mm annual EBITDA. Ceres' original investment in the SSR in December 2010 was $1.7 million for its 25% interest. So they picked a very high rate of return project once before.

Neither the SSR nor the Riverland segment seem like that much earnings power for a company with a $100 million market cap. So what do VN Capital and Whitebox see here? Maybe it's the company's Northgate project,

"We are in the process of constructing a new commodity logistics centre on 1,300 acres of land, located on the border between Northgate SK and Northgate ND, effectively linking Saskatchewan’s resources to the U.S. Midwest. The Northgate Commodity Logistics Centre is designed to utilize high-efficiency rail loops, capable of handling unit trains of up to 140 railcars. The site will initially contain a grain handling and shipping facility, followed by the construction of an oil and natural gas supply logistics centre to facilitate exports from Saskatchewan’s and Western Canada’s energy sector. A frac sand, pipe and cement unloading centre will be added to bring these products in from the United States to service Western Canada’s energy industry."

This could be interesting. Here's a map of where the Northgate project will go:



That looks like a good place for a rail link. Here's what they say about the cost:

"an additional investment of approximately $112 million over the next 3 – 5 years, is required for NCLC to reach full capacity including a 2.2 million bushel grain elevator, 7 2 ,000 barrels per day of oil capacity and 29,000 gallon per day in natural gas liquids capacity. Within th is budget, approximately $35 - 40 million is required to complete the first phase of the project which would enable the movement of grain, oil and natural gas liquids."

In the investor presentation, management thinks that the Northgate grain operations could generate $3.8 million in EBIT and the oil and NGLs over $20 million in EBIT.

Here is what VN Capital said about Ceres in their investor letter,

"Formerly an agriculture sector closed-end fund, Ceres is now a fully-fledged operating company with grain elevators and storage and processing facilities in the US and Canada. Last quarter we said that we would likely have more to say in 2014 regarding our investment in Ceres. We certainly do. In one fell swoop in June, we purchased 7% of the entire company. Like any other investment we make, this investment is grounded in fundamentals and is based on the opportunity to realize long term value. This situation, however, is different in that it puts us in a position where we, as the largest owner, can contribute meaningfully to the direction and pace of developments at the company, and we have wasted no time. After many years of incoherence, mismanagement and, most importantly, a lack of vision, Ceres is now moving ahead aggressively to resurrect its legacy grain business as well as build out its greenfield Northgate Commodity Logistics Hub on the North Dakota/Saskatchewan border. This last project is an enormous opportunity, the likes of which is not normally available to an investment vehicle such as the Partnership, which is why we have been aggressive in devoting capital as well as time and energy to Ceres. We have an exceptionally talented Board of Directors that is up to the task, and, although a lot of work remains to be done, we expect that Ceres will turn a corner at some point to become a meaningful contributor to the Partnership’s future returns. Our holdings of Ceres represent 11.1% of the Partnership’s assets."

They also discussed it in Value Investor Insight (this was in 2012, before some of the recent significant changes to the business,

"The backstory here is that Ceres was formed in late 2007 by Front Street Capital to invest in the then-hot agricultural commodity boom. Within a year those markets crashed as the recession hit and management shifted focus to hard assets with the purchase of a dozen privately held grain elevators from a Minnesota-based hedge fund manager, Whitebox Advisors. In 2011, Ceres announced it was going to run off its investment portfolio and reinvest the cash into similar operating assets. As we studied grain elevators, we concluded the business was similar to that of the cement business, where we’ve invested with some success before. There are high fixed-cost assets, with a good that is fairly low in value but bulky and expensive to transport. That allows cement companies to have natural monopolies near their plants because it’s a lot cheaper to buy cement from the guy who’s 10 miles away than 200 miles away. The same thing applies with grain elevators, but kind of in reverse. If you’re a farmer, it’s a lot cheaper and easier to transport your grain to the elevator that is very close than one that’s far away. In these situations it comes down to what you pay for the fixed assets – the lower the price, the higher your return. In Ceres’ case, we believe we were able to buy those fixed assets for free.

The current market cap is around C$83 million. Using year-end March numbers, reflecting a full harvest season, Ceres had around C$40 million in cash and run-off investments. It owned C$160 million worth of grain in its elevators, against which it had C$80 million of debt. At the fund level there was also another C$40 million in debt. So for less than C$5 million at today’s price, you’re getting the grain-elevator assets and the profits they generate. It recent years those profits have been as high as C$12 million, with an average of around C$8 million. Discount that average annuity at 10%, and that’s C$80 million in value right there.

One significant thing happened in the third quarter of this year, which is that the Canadian Wheat Board officially lost its monopoly to purchase Canadian wheat. That opens up a significant new base of potential customers for Ceres’s assets, many of which are located in the U.S near the Canadian border. The business will continue to fluctuate somewhat based on weather and crop yields, but the new demand should have a positive long-term impact on both capacity and pricing. Another upside we see here is that as the non-elevator portfolio is sold off, there will be no need for Ceres to maintain its closed-end fund structure. Savings related to that could add another C$2 million or so annually to the bottom line."

The company looks worth keeping an eye on.

S&P Futures Below 200-Day Moving Average

This ought to be good for a pretty good correction. See Hussman.

Hussman On The Impending Crash

Today

"Fed easing is effective provided that risk-free cash is considered an inferior holding. Fed easing is useless if investors actually prefer to hold risk-free cash as a safe haven.

There’s certainly a feedback circle to this: the purely psychological belief that Fed liquidity is a magical risk-removing fairy dust can certainly support increased risk tolerance, but that tolerance should still be read directly out of market internals and trend uniformity. When investor preferences shift toward risk aversion, more liquidity doesn’t support stock prices. Yield-seeking speculation fails to emerge because low or zero interest rates on cash are preferred to the prospect of steeply negative returns. As the market collapses of 2000-2002 and 2007-2009 demonstrate, aggressive Fed easing does not prevent extraordinary market losses once investors have the risk-aversion bit in their teeth."

Comment on the Radio Shack Comment $RSH

A commenter on the howardroark / Radio Shack comment post:

"It is abundantly clear that there is a shortage of good collateral for both the first and second lien paper (hence the reserves by GE against the borrowing base when they owned the loan that was recently sold to Standard General).

Given that, the only two rational responses for Salus are 1) liquidate the company or 2) force the company to add more collateral in a position junior to them before they relent on the ability to close stores. Hence the stalemate, the company doesn't want to liquidate and every store closing dilutes Salus' collateral position (since store inventory proceeds are usually consumed by lease expenses.)

Salus is better off with the company in BK and the landlords taking a significant share of the liability cram down."

"Fitch Affirms Banner Health System's (AZ) Rev Bonds at 'AA-'; Outlook Stable" $NAZ

Good to know - this Banner hospital bond is largest holding of the NAZ muni fund:

"STRONG AND CONSISTENT PROFITABILITY: Despite continued revenue pressure from lower volume, Banner has been able to maintain strong and consistent operating results that exceed Fitch's 'AA' category medians. From 2010-2013, Banner has generated operating margins between 5% and 6.1% and operating EBITDA margins between 13.1% and 14.6%, which is well in excess of the respective 'AA' category medians."

BACH Prelude and Fugue in D major BWV 532 for Orchestra

howardroark On Bet Sizing

Very good:

"even when I have an opinion on a company's value versus its market price, I try to consider how fragile that opinion is. That is, because I understand that being in the business of actively picking stocks as opposed to passively minimizing risk across thousands of baskets, I not only seek situations where I have an opinion, but those where I can have as much certainty and precision as possible. The less certainty and precision I felt I had, the greater return I would require and the smaller portion of my capital I'd be willing to commit to that investment. The more you choose to eschew certainty and seek return, the more important it is to diversify your bets. Even if you get someone to give you 40:1 odds at roulette wheel, you'd better be sure you're making a lot of bets. [...]

I respect the fact that, even in cases where I feel relatively certain, I still can't perfectly predict the weather. I can't know for sure if pipeline will run dry, or consumer tastes will abruptly shift, or a technological disruption will come out of nowhere, or if the company has for years been violating federal Medicare laws. So even after restricting myself to situations where I feel I have a valuation opinion and a higher than normal degree of certanity in my ability to see the future, I still try to avoid imprudent concentration of risks."

Radio Shack Case Study

Excellent post by howardroark at Motley Fool forums:

"Salus is blocking the fire escape. Why?

Well, I promise you it is not because Salus is extremely optimistic that Furby II is about to turn the clock back on those 1100 stores to 1986. I can really only think of two reasons to stand in the way. One, $250 million is kind of a big deal to a not-enormous shop like Salus who only has $724 million in total ABL in its portfolio (they are majority owned by HRG, which reports as a public company). When they did the deal, the stock was a $2.50-$3.00, and more importantly the $324 million in 2019 unsecureds below them was at 70c. The point being, things very quickly turned worse just a few months later when they missed estimates by a country mile and the unsecured fell to 45c. So maybe Salus just saw a chance to play chicken by withholding its consent to an obviously beneficial decision to either get more fees, or more likely to get a chunk of the liquidation proceeds to pay down some of the term loan.

It may secondarily be true that store liquidations are asymmetrically worrisome for Salus. Normally the senior secured won't ferociously stand in the way (maybe just some nominal extortion) of desperately needed retrenching, because to the extent stores are liquidated and inventory is sold the borrowing base availability declines. With that decline the retailer is basically forced to pay down the ABL anyway. But here where Salus is holding a junior lien on the inventory and already fully extended, less inventory without paydown is a negative credit event for them if the Company burns the proceeds. It is also a negative credit event to the extent the closures include some payouts to landlords who are otherwise junior to Salus."

"China Tariff On Imports Could Dramatically Impact Already Hard-Hit Coal Producers" $WLT

Forbes:

The decision by China – the world’s top coal importer – to put a 3% tariff on anthracite and coking coal and 6% tariff on thermal coal reverses a near decade-long policy to remove barriers to imports, making a near-term rebound in coal prices increasingly less likely, analysts say.

“The timing of a met coal price rebound is becoming increasingly important for liquidity-constrained met coal producers Walter Energy, Alpha Natural Resources, Arch Coal,” said Morgan Stanley

Another Look at Oil Futures Curves

Commodities And Producers Are Just Leading The Deflation/Inflation Cycle

A commenter on my crude oil futures post pointed out,

"Commodities and commodity producing stocks are the only stuff out there that is reacting to fundamentals! The resource sector is telling the truth. The cocktail stocks and momentum favorites are telling lies!!"

Commodities do seem to be the quickest to pick up on changes as we move through this cycle:

Inflation/mania -> tightening -> deflation/crash -> printing

This is a positive feedback loop. One would expect the oscillations to become wilder as people attempt to "get in front of" the next step, and that does seem to be what has happened over the past 15 years or so.

The alternative to cycling the printing on and off is to attempt to use "tawk" to keep the goldilocks economy:

"Wednesdays action was quite incredibly naive. The Fed is halting QE, it is no longer lowering rates. In short, the Fed is tightening, and at the same time successfully counteracting the market effects of that tightening with dovish talk at their conference in which they decide to remain on the tightening course. That is the whole purpose of forward guidance - to get the stockmarket to react to their words and speeches and to ignore what they actually do, or neglect to do."

But tawk and no printing makes people nervous. No one can afford to get left behind in a change in the inflation/deflation cycle. The way you make a lot of money is to get in front of it.

What happens if China loses the ability to build concrete and steel boondoggles at the same time the Fed is shifting into a tightening cycle? Well, commodities get crushed:

They're trading at a four year low, and the deflationary cycle has just started! The DBC index is heavy on energy (65% various energy products), the rest is agricultural and metal. But they are all falling.

A reason the oscillations could get wilder is that investors want to avoid drawdowns, and they get trained by experience as we go repeatedly through the loop. If the Fed doesn't "have your back", you don't want to own any commodity, producer, or maybe even anything at all as the deflation spreads. But when they stop tawking and start printing, there will be a violent reversal.

Crude Oil Futures Curve Has Flattened Out

The crude oil futures curves, at the beginning of the year in green and right now in orange. They've flattened out. Oil for delivery any time after about three years from now is more expensive now, even after a big correction in oil, than it was at the beginning of the year.

It's interesting; oil names have gotten crushed across the board, but anything with long reserve life should probably have higher present value now because the out year contracts have rallied.

Doing some rough math, at a discount rate of 10% the next 9 years of oil contracts are worth about $480 now vs $470 at the beginning of the year.

With Canadian Oil Sands getting slammed down almost to a three year low (down 25% from July peak), all that oily dirt in the ground is looking cheap.

WSJ: "Hong Kong Pops the China Bubble"

Bret Stephens:

"Don’t tell that to the people of Hong Kong, who have learned the hard way that, except when pressured, Beijing honors no promises, countenances no dissent and contemplates no future in which the Communist Party’s grip on power can be loosened even slightly. Hong Kong became rich on the small government, laissez-faire, rule-of-law-not-men principles of its late colonial administrators. It has remained rich because, by comparison to mainland China, it remains relatively free and uncorrupt. Hong Kong is what China could be if it weren’t, well, China—if state intervention were minimal; if government weren’t a vehicle for self-enrichment; if people could worship, write, exercise and associate just as they please."

Great piece! China is a joke!

Comment On My Now "Classic" Seeking Alpha 2011 Silver Thread $SLV

In January 2011, one of my posts - Watch Out For The Silver Bubble - was posted on Seeking Alpha. The silverbugs were apoplectic. However, as I pointed out at the time

"The massive margin between the spot price and the cash mining cost is going to cause a huge increase in supply over the next few years. Pan American Silver projects that it can raise production from ~20 million ounces to 45 million by 2014. (In the entire year 2010, the U.S. Mint minted and sold under 40 million ounces of silver.)"

For a variety of reasons, silver has indeed gotten crushed. I saw just today there was an astute comment on the thread (which is now almost four years old):

"I am a mega buyer in the $9 to $10 range - the low for silver in Oct. of 2008.

Right now the Fed is worried about its own survival and wants to hand the fiscal great recession hot potato back to congress. But once the Fed sees the economic collapse drawing near, they will print and shower the currency on main street rather than squirreling it away in bank reserves.

When that happens I want to long and leveraged in silver.

My guess is that $9 to $10 is the zone coincident with max pain for the Fed and for the economy. I would like to see a lower low in price at that level with a higher low on the MACD before going all in."

Speaking of Pan American Silver, their latest investor presentation has a 2014 production target of 26 million ounces. Much less than the 45 million that they projected back in 2011. They claim a cash cost of $12 per ounce.

Still, they were able to increase production by 30% over three years even though the price has gotten cut almost in half.

Single digit sounds like the right price target. Mines should be closing down at that point.

"DOG DAYS OF YULIN"

"Stolen pets and strays making their way to the dinner table."

As Philip Mountbatten says, "If it has four legs and is not a chair, has wings and is not an aeroplane, or swims and is not a submarine, the Cantonese will eat it."

Crude Oil vs Treasuries

The Admiral writes in:

"It's impossible for these two curves to both be right. Oil is going to have an awfully hard time cratering while rates are rising and vice-versa. Interesting to see them on top of each other, possible pair trade using calendar spreads on both contracts."

An Obsolete Retailer In Runoff

I've been looking for an electronics retailer that has done what I say Radio Shack should have done; go into runoff for the benefit of shareholders. A correspondent suggested TWMC:

"Trans World Entertainment Corporation is a chain of entertainment media retail stores in the United States. It currently operates just over 350 freestanding and shopping mall-based stores under several brand names, down from about 540 in August 2010. [That's closing 9% of stores per year.]

On Wednesday, November 28, 2012, Trans World had two big announcements. First, they sold real property that they owned in South Beach, Miami, Florida, for $30 million. Prior to the sale, Trans World has been leasing the property to Walgreens. They purchased the property for just $7 million back in 2007. Secondly, they announced a $0.47 per share special cash dividend, payable to shareholders as of December 10, 2012. Trans World will pay out $15 million in cash to shareholders in this dividend payout, which will be made on December 26, 2012."

Closing stores, selling real estate, paying dividends. That sounds like a runoff. They also paid a 50 cent dividend in March 2014. The company has also bought back $5 million of stock over the past year.

The market cap is $112 million, but there is $156 million in net current assets, of which $86 million is cash. Putting a haircut on the inventory and assets, the market cap seems to be about liquidation value. Not super cheap, but cheap relative to Radio Shack which has roughly the same market cap!

Here's a key difference between TWMC and RSH: there's a former CEO of TWMC, Robert Higgins, who owns 45% of the company. That makes it less likely that money will be wasted on store renovations and "super bowl" advertisements.

You can see the difference in share performance over the past three years - not even counting the special dividends that TWMC has paid!

This pair should continue to do well: TWMC continues returning cash and RSH crashes into the mountain.

Most of the TWMC stores are the "fye" (for your entertainment) stores.

The stores are mostly mall stores, but there are some freestanding stores. All but one of the stores is leased, and 78% of the leases expire by the end of 2015. So, they should have all the flexibility they need to close more stores if necessary.

TWMC has had 35% gross margins in the last fiscal year. They are incredibly stingy with capex, the way a company in runoff should be. Only $13.3 million combined over the three fiscal years ended this year. That's about what Radio Shack spends on a "super bowl" ad.

They seem like better retailers than Radio Shack. They talk about actual retailing, for example:

"Inventory turnover measures the Company’s ability to sell merchandise and how many times it is replaced in a year. This ratio is important in determining the need for markdowns and planning future inventory levels and assessing customer response to our merchandise. Inventory turnover in Fiscal 2013 was 1.6, the same level as Fiscal 2012. Inventory investment per square foot measures the productivity of the inventory. It is important in determining if the Company has the appropriate level of inventory to meet customer demands while controlling its investment in inventory. Inventory investment per square foot was $74.0 per square foot at the end of Fiscal 2013 as compared to $70.4 per square foot at the end of Fiscal 2012. Accounts payable leverage measures the percentage of inventory being funded by the Company’s product vendors. The percentage is important in determining the Company’s ability to fund its business. Accounts payable leverage on inventory was 51.7% as of February 1, 2014 compared with 51.1% as of February 2, 2013."

Part of what we see with TWMC is that when you don't have too much debt, it's easier to be in control of your own destiny.

Correspondent Comment on Denmark and NATO

"Denmark wants to be a serious military player in NATO.

These dimwits cannot seem to figure out, even after the U.S. banks financed the destruction of Europe in two world wars and profited massively on the rebuilds that followed, that NATO is nothing more than a setup to do the same thing again - start a war, reduce Europe to rubble and then rebuild it and make a fortune in the process.

They don't see it even though Russia has announced that they will immediately launch a massive tactical nuke attack against European NATO countries if NATO moves against them. Do these clowns in Denmark really think that reducing Europe to rubble would necessarily cause either the U.S. or Russia to destroy themselves by launching ICBMs at one another?"

Very Good Analysis of Radio Shack Deal From Correspondent $RSH

A correspondent writes in about the Radio Shack deal,

"They state that the investors will put up $120MM cash to be used to collateralize lines of credit and that it is expected to be converted into equity. And in the next sentence they say 'Current shareholders will have the opportunity to participate in a rights offering at same conversion price.' So everyone's cash is going into the equity at $.40 per share, therefore the conversion of the cash collateral element of the deal would give the investors 300MM shares.

But if you read further down, they talk about issuing a minimum of 400MM shares and if no public shareholders participate in the rights offering, they will own 20% of the company’s equity securities, which given that there are 100MM out now, means that 400MM would be issued to the investors. So where do the extra 100MM shares come from – the answer must be $40MM in fees paid in shares. Note this language from the release: 'The $120 million investment is expected to be converted into equity securities representing (together with related fees payable in equity securities) not less than 50% of the Company's outstanding equity securities upon satisfaction of certain conditions.'

So if they get 100MM shares in fees, for agreeing to assume the first lien deal and amend it, and for putting up the cash collateral (whether that collateral has 1st or 3rd lien status is still ambiguous to me), then they have control of the equity of the company while having most of their investment in a first lien position (other than, perhaps, the cash collateral backstopping the letters of credit) and won’t be forced to convert their cash to equity unless the rights offering is done, the supplier contract is modified, and the company has $100MM of liquidity (before their money goes in) at 1/15/16.

So to net it out, their 'at risk' capital is primarily or maybe totally first lien, and worst case, they get a free look at the fourth quarter and whether the company can raise $120MM in a rights offering while securing a control position in the company, before they expose any of their capital to a pure equity risk. Maybe we have underestimated Standard General's negotiating acumen. If the Hail Mary play works and there is a sustainable business here at the end of the day, they have acquired enormous optionality in the equity while putting very little capital at risk of a permanent loss. Not bad. "

The other thing our correspondent points out is the desperation for liquidity that this deal fee shows. And, from my earlier post, we see that the company has been losing over $1MM a day for the past two months, which is the key issue for the company and shareholders, and which this deal does nothing to address. (Ultimately a question of store closures and the number of stores that are profitable.) And there is still no agreement with Salus to permit store closures!

WSJ: "RadioShack Lifeline Only Buys a Little Time" $RSH

Best WSJ article on the negotiations.

"RadioShack executives in recent weeks discussed a more substantial restructuring with lenders including Salus Capital Partners LLC but opted for a stopgap plan, fearing those negotiations weren’t moving quickly enough to free up cash ahead of the holidays"

Key detail:

"RadioShack had less than $100 million available under its cash reserves and credit line by the time its board agreed to the financing deal, a person familiar with the matter said, down from about $180 million on Aug. 2."

That means they burned $80 million in two months.

People who bought in the pre-market on Friday morning found out that the details weren't as good as they thought.

"RadioShack: That's Not the Loan We're Looking For" $RSH

From B Riley

"Although this frees up some borrowing availability and should help liquidity optics for holiday inventory build, there didn't seem to be any assurances that vendors were supportive. Furthermore, Salus Capital (term loan lender) does not seem to have budged on covenants, which means widespread store closings are still not permitted. Given the magnitude of ongoing losses, the significant potential dilution, and some of the language in the company's release, we think the announced agreement simply pushes a likely bankruptcy filing out until after the holidays. We therefore reiterate our Sell rating and $0 PT."

"RadioShack Rescue Package Decried as Stopgap Measure" $RSH

Bloomberg article

"'While we believe this financing package should allow RadioShack to avoid a near-term bankruptcy filing, it comes at a heavy cost to existing shareholders and may only serve to forestall its ultimate demise,' Anthony Chukumba, an analyst at BB&T Capital Markets in New York, wrote in a note today.

The new package values RadioShack at 40 cents a share, calculated Michael Pachter, an analyst at Wedbush Securities in Los Angeles. If the $120 million is converted to equity of 300 million shares, existing stockholders will retain only about 25 percent of the ownership, he wrote in a note today. Pachter has a $0 price target on the stock."

Offshore Drilling Crash?

Check out this chart from StockCharts.com for SDRL

What an ugly chart!

SeaDrill is just an example; an offshore drilling services provider with 15 semi-submersible rigs, 7 drillships, 20 jack-up rigs, 3 tender rigs, and 24 units under construction. Here is one perspective on what's happening in offshore drilling:

"[T]he industry is suffering from falling oil demand and the sudden influx of new vessels is increasing capacity beyond optimal levels, leading to overcapacity. The vessel influx happened because orders for vessels were placed during the industry boom, but are being delivered now.

There are still pending orders for new ultra-deepwater rigs, equal to half of the quantity of the existing fleet. Analysts estimate that a third of these new rigs will be delivered over the next three to four years, and they will not have orders for oil drilling.

In addition to these factors, rig rates have also fallen substantially in the last 18 months, because oil and gas companies are cutting capital expenditures and are increasing cash reserves to pay higher dividends."

One thing noteworthy is that Conrad's prospects are closely tied to offshore oil and gas. So far, there has been no big decline in Conrad, but in May it broke decisively below its longstanding ascending trendline and below its 50-day moving average. In August, it fell below the 200-day moving average and the 50-day crossed below the 200. I've closed out of Conrad - I hope it goes back to the $20s.

Also, these company managements can't seem to stop themselves from being procyclical and making bad bets. Same thing that happened with Walter.

Paul Graham On "Before the Startup," And The Startup Bubble

Paul Graham has written his first new essay in almost a year, "Before the Startup". It seems like his essays have had a long interruption, ever since he wrote one that was politically correct by 2010 standards by not politically correct enough by 2014 standards.

I like the new essay, and his thoughts on startups in general, but he is an uber-bull on startups.

I think the flaw in his thinking is that, while a startup may be making something that users want (all-important in his view), lots of people want things at a price of $0 that they wouldn't want at a price of $n>0.

I've never seen him write an essay about what type of products, originally given away for free, will subsequently be possible to charge for.

People say that these free products will be advertising supported. Let's see, if it's very cheap to start a website that will attract users who can be served ads, what does that say about: (1) the future prices of ad placement, (2) where the rents from advertising will go?

Being able to serve ads was historically a great business, but that was when there was a very high fixed cost and low marginal cost of serving the ads.

Google has a market cap of $400 billion and Facebook has a market cap of $200 billion; $600 billion combined. Google has EBIT margins of 23%, Facebook (which is a purer look at advertising margins) has EBIT margins of 36%.

Global advertising spending is about $550 billion. Only about a quarter of that is digital. That implies that digital advertising is creating about $50 billion in operating profit.

I get the impression that the glut of capital from VCs has led to something on the order of 5,000 startups. It seems as though what's left of the advertising pie isn't enough to justify the valuations at which these have raised money.

My other big problem with advertising-supported giveaway businesses, besides the nonexistent barriers to entry, is that advertising is a bet on middle class discretionary spending. We already know that global elites have decided to gut the middle classes. Do the VCs have a variant perception, or is it hard to see from inside their Silicon Valley bubble, just like it was hard to see the real estate bubble from inside Manhattan?

China Electricity Production Falling

Suspicious. I think this is basically the GDP number. There's no way GDP was growing in 2008 (as they claim), and judging from that it may be falling now.

Treasuries Back in Uptend $TLT $ZROZ

Check out this chart from StockCharts.com for ZROZ

What a beautiful chart. Can you believe there are people who believe this is going lower??

Look how it bounced back in a hurry. I see it taking out the 2012 high.