Tuesday, May 3, 2016

Seacor Holdings Annual Report $CKH

I thought this was interesting - from the Seacor Holdings 2015 Annual Report [pdf]

That there is no impairment charge according to GAAP does not mean that book value represents an achievable price were the asset today offered for sale. I would be happier if GAAP would, like international accounting rules, allow “mark-to-market” accounting for our fleet and permit me to delegate to a broker, or an appraiser, the responsibility for periodically determining a “clearing price” for our assets.

In the past, I have steadfastly refused to provide a SEACOR view of the value of our assets. There are many reasons for not doing so, apart from the army of lawyers who counsel reticence. My preference is to provide SEACOR stockholders information to reach independent conclusions. In this letter you can find the original cost of equipment, current insured values, book carrying costs, and historical information about earnings of different classes of equipment. The ability of our management group to divine the future is not necessarily much better, if indeed at all better, than that of our stockholders, journalists, “sell side” analysts, or palm readers.

In the absence of willing buyers and willing sellers for secondhand equipment, I generally default to replacement cost as the most useful point of departure. Manufacturers (shipyards in our business) are always willing sellers. Of course, the real cost can be elusive. Without a transaction born out of the crucible of negotiation, a shipyard’s list price is an “ask.” From replacement cost it is feasible to extrapolate an approximate value range for secondhand equipment, even if there are no “willing buyers” or “willing seller.”
Sadly, in the 2013 letter [pdf], there was no hint that oil was about to crash.Will be interesting to monitor this one - potential future restructuring candidate.

Also (as he discusses in this year's letter), they'll have to start making tough decisions about maintenance (special surveys, etc) on the idle ships.

Sunday, May 1, 2016

Not Bullish On Bonds

Last summer I noticed that the possible bond bear market was three years old. Now we might be four years into it!

Not saying that it's going to happen, but it's going to upset a lot of people's plans if SPX starts falling and bond yields start rising.

People are used to an overall falling interest rate trend (since Sept 1981!), which has been a tailwind for asset values, but they are also used to a shorter term inverse correlation where people flee equities for the safety of bonds.

That's the principle that 60/40 asset allocation is based on - if you own stocks and bonds, at least one will always be "working".

But remember Charles Dow Looks at the Long Wave: that pattern that asset allocation is based on has existed because we've been in the long period in between the peak in interest rates and the peak in stock prices, as Charles Kirkpatrick explained:

"The period after interest rates peak is when stock prices rise as an alternative investment. During that period declining interest rates force yield-conscious investors into alternative investments of lesser quality in order to maintain yield. Since stocks are the most risky and least quality investments, they become the final alternative, especially when their price continues to appreciate as a result of increasing cash flow into the stock market. [positive feedback loop] The recent conversion of government-guaranteed CD deposits into stock mutual funds is typical during this period. Unfortunately, it eventually leads to the declining long wave in stock prices."
There could be a period when stocks and bonds go down together. For example, instead of stock declines -> people wanting the security of bonds, people might decide that stock declines lead to bailouts which are really stealth currency devaluations, and decide they want no part of the long end of the yield curve.

Remember, all of the federal, state, and municipal governments are planning to borrow to cover their operational and pension shortfalls. They think it will be no big deal thanks to low interest rates. In the most recent Fortune, Trump essentially says that he would grow the national debt - he's a developer and he loves low interest rates!

I've said that the federal public debt was only $6 trillion when Bush left office, and there's easy ballpark math that says that within a decade, the public sector will need to borrow that much every year.

The other scary thing for bonds is the effect that interest rate increases have on this system, because it contains so many feedback loops. The pension assets become worth a lot less, the interest expenditures rise (and they are borrowing to pay the interest since there is no debt service), so the credit quality (such as it is) deteriorates.

Also, corporate pensions have the same problem and an interesting feedback loop of their own. To the extent that their pension funds lose money, earnings will take a hit. As we know from Grantham, when earnings fall multiples fall too.

It is very, very nonlinear, because once bonds lose momentum, who will want to own them? Professional asset management and retail investor sentiment are both all about momentum. And every credit - government or corporate - looks much worse with rising interest expense. I think we will come to realize that a lot of stuff in the economy (junk bonds, private equity) was part of a virtuous interest rate cycle.

For the counterargument that the Fed will just buy bonds to "keep rates low", you have to face the fact that QE invariably caused rates to rise, and you could (and we did) make money buying bonds every time the Fed stopped buying them. As I kept trying to explain, the QE bond purchases may have been respectably large in relation to the flow of debt issuance, but they were puny in relation to the stock of $60T of dollar denominated debt. It freaked creditors out about inflation more than it helped.

The legitimate purpose of public debt is to borrow money to build infrastructure improvements that have a positive net present value. However, a vast portion of federal expenditure now leaves nothing tangible, leaves no collateral. A treasury bond is a certificate that money has successfully been expended on section 8 housing, or on make-work military "jobs".

The lack of collateral makes these treasuries creatures of social mood. They are no more valuable than tulip bulbs or south sea shares. That makes them vulnerable to going down with stocks when social mood becomes more pessimistic.

If you synthesize the best parts of Falkenstein and Redleaf, you predict that the next crisis is going to come in the investment that is currently perceived as riskless enough for highly leveraged institutions like banks to buy. Right now, government bonds are accorded zero risk in calculating bank capital ratios. The idea that government bonds are riskless when governments are planning to flood the market and when the expenditures are consumed (building no collateral) may prove to be the latest extraordinary popular delusion.

Krugman has spent years poking at the "invisible" bond bear. The problem is that years of success at borrowing for consumption (not investment) without any noticeable effect on interest rates made the Keynesians in government complacent and cocky.

P.S. For Buffett fans: he didn't become a billionaire until 1986, five years after rates peaked. 99% of his net worth was made during the declining interest rate trend.

Junk Bonds Are a Creature of Falling Interest Rates

Man, Gundlach is a lot smarter than Bill Gross.

Wednesday, April 27, 2016

Thoughts About Failing Businesses

I was just looking at the list of companies we've blogged about as potential failures that either did fail or else essentially wiped out shareholders in a restructuring:

First I looked at them in terms of industry categories. The biggest category was coal/mining, with 7 companies. Molycorp was what you call a science project stock, funded with expensive debt, not too hard to see poor equity returns coming there. But the six coal companies were on top of the world in 2011. Much cheaper natural gas came out of nowhere and destroyed them.

To have rationally invested in those coal companies, you needed to know what coal prices would be many years in the future. But that means knowing about the prices of coal's competition for electrical generation (natural gas, solar, etc.) which is tough.

The next category is oil & gas, where there were six failed companies. This is pretty similar to the thoughts on the coal companies; in fact the oil & gas glut is in a sense what caused all the coal failures. Once again, there were very explicit oil price assumptions that were necessary for the success of the companies' capital expenditures and for the success of equity investments in those companies.

Financials had six failed companies but they were all 2007-2009, there haven't been any recently obviously thanks to reflation. Maybe what's noteworthy is that they were extremely levered, which magnified the effect of bad investment decisions.

Next category is solar and alternative energy, with five failed companies. The alternative energy ones were once again science project stocks. Maybe it's a bad idea to invest in public companies with 9+ figure enterprise values that don't yet have a product that they can sell for more than it costs to make. And then the photovoltaic solar companies were dealing with a product where the underlying technology was rapidly improving but they had sunk huge capital into manufacturing plants. Also, there's the theory that the Chinese PV solar firms were a deliberate bust-out to take advantage of naive American investors.

Two of the firms were pharma - those fit the science project category again. Then two were shipping and two were building materials: firms that run with a lot of leverage to make up for low margins that come from undifferentiated products.

One thing that would be interesting to look at is how much these companies spent on capex in the final years of their lives when the businesses should've been in runoff mode. For example, Radio Shack was remodeling stores and buying "Super Bowl" ads right up until the end.

It's also remarkable how quickly the change from extreme best-ever success to failure can happen. In fact, it's almost as though those extreme levels of success can signal big change ahead.

Friday, April 22, 2016

Thursday, April 21, 2016

Great Review of Trump's The Art of the Deal

Great review:

I started the book with the question: what exactly do real estate developers do? They don’t design buildings; they hire an architect for that part. They don’t construct the buildings; they hire a construction company for that part. They don’t manage the buildings; they hire a management company for that part. They’re not even the capitalist who funds the whole thing; they get a loan from a bank for that. So what do they do? Why don’t you or I take out a $100 million loan from a bank, hire a company to build a $100 million skyscraper, and then rent it out for somewhat more than $100 million and become rich?

As best I can tell, the developer’s job is coordination. This often means blatant lies. The usual process goes like this: the bank would be happy to lend you the money as long as you have guaranteed renters. The renters would be happy to sign up as long as you show them a design. The architect would be happy to design the building as long as you tell them what the government’s allowing. The government would be happy to give you your permit as long as you have a construction company lined up. And the construction company would be happy to sign on with you as long as you have the money from the bank in your pocket. Or some kind of complicated multi-step catch-22 like that. The solution – or at least Trump’s solution – is to tell everybody that all the other players have agreed and the deal is completely done except for their signature. The trick is to lie to the right people in the right order, so that by the time somebody checks to see whether they’ve been conned, you actually do have the signatures you told them that you had. The whole thing sounds very stressful.

Friday, April 15, 2016

LINN Energy Announces Updates $LINE

As previously announced, the Company is currently in the process of exploring strategic alternatives to strengthen its balance sheet and maximize the value of the Company and has engaged its financial and legal advisors along with its lenders in discussions on how to best reduce the Company’s debt and ensure its long-term liquidity needs are met, including the possibility of restructuring under a chapter 11 plan of reorganization.

As part of this process, LINN and Berry intend to elect to exercise the 30-day grace period with respect to an interest payment due April 15, 2016 of approximately $31 million on LINN’s 8.625% senior notes due April 2020 and interest payments due May 1, 2016 of approximately $18.2 million on LINN’s 6.25% senior notes due May 2019 and approximately $8.8 million on Berry’s 6.75% senior notes due November 2020. If LINN fails to make the interest payments within the applicable 30-day grace period and is otherwise unable to obtain a waiver or other suitable relief from the holders under the indentures governing the senior notes prior to the expiration of the 30-day grace period, the resulting default under the applicable indenture will mature into an event of default, allowing the noteholders to elect to accelerate the outstanding indebtedness under the senior notes.

On April 12, 2016, LINN entered into the Eighth Amendment to its Sixth Amended and Restated Credit Agreement among LINN, Wells Fargo Bank, NA, as administrative agent (the “Agent”), and the lenders party thereto. The Eighth Amendment provides:

    An agreement that certain specified events will not become defaults or events of default until May 11, 2016;
    The borrowing base will remain constant until May 11, 2016, subject to reductions based on sales of assets or termination of hedge agreements; and
    LINN, the Agent and the lenders will negotiate in good faith an agreement in furtherance of a restructuring of the capital structure of LINN.

In addition, on April 12, 2016 Berry entered into the Twelfth Amendment to its Second Amended and Restated Credit Agreement among Berry, Wells Fargo Bank, NA, as administrative agent (the “Berry Agent”), and the lenders party thereto. The Twelfth Amendment provides:

    An agreement that certain specified events will not become defaults or events of default until May 11, 2016;
    The borrowing base will remain constant until May 11, 2016, subject to reductions based on sales of assets or termination of hedge agreements; and
    Berry will have access to $45 million in cash that is currently restricted in order to fund ordinary course operations; and
    Berry, the Berry Agent and the lenders will negotiate in good faith an agreement in furtherance of a restructuring of the capital structure of Berry.