Putting the Silver Bubble in Perspective ($SLV, $PPLT)

A great way to shed light on the silver bubble is to look at the silver/platinum ratio, as expressed by the physial silver and physical platinum ETFs.

Rather than speculate on the price of silver (or any other commodity) it is helpful to look at the ratio of two things that are at least somewhat substitutable. If platinum can satisfy some or all of the demand for silver - say for investment purposes - then you would expect the price ratio to be mean reverting.

We already know that the gold/platinum ratio is strongly mean reverting once an ounce of gold costs more than an ounce of platinum.

I wonder whether the "cheapness" of silver - not in an valuation sense, but in the sense of an arbitrarily low price per ounce - has led to irrational demand from small investors? That would not bode well for the silver price.

Pair Trade Idea: Discovery Communications (DISCK/DISCA) Share Class Arbitrage

Here's an idea: an arbitrage between the two classes of Discovery Communications stock (DISCK/DISCA).

The two classes of stock are economically equivalent, but the DISCK trades at a ~15% discount to the DISCA.

Here's a chart of the spread over the past two years. It seems to be "stuck" around the current level, although the company may be working to close the gap by targeting all of its buybacks on the class that trades at a discount.

Probably, the best way to make money on this type of situation would be to monitor the spread and step in with capital when the discount is extreme.

This type of trade is attractive because it is not really correlated with the market. Having trades in the portfolio with positive expected value and low correlations is beneficial.

Regency Centers (REG) Stock Offering is Good News for Our Pair Trade

Regency Centers Corporation (REG) announced today that it will sell 8,000,000 shares of its common stock.

That is good news for the REG / REG-E pair trade I have on. Increased supply of REG shares will weigh on the market incrementally more, while creating a larger equity cushion to support the preferred, REG-E.

Adding to REG/REG-E Trade

The spread on my REG/REG-E pair trade has moved against me over the past week, so I added more capital to it today.

One of the attractions of this trade is that REG-E yields 8.2% Here is the prospectus for REG-E.

Time to Unwind the Georgia Gulf (GGC) and Olin (OLN) Pair Trade

The Credit Bubble Stocks pair trade of GGC and OLN was posted at prices of $29 and $16.5, respectively. GGC has fallen to $15.65 and OLN to $15.79 as of right now, which were declines of 46% in the short and only 4% in the long. The pair worked brilliantly.

GGC's performance and adjusted EBITDA was better than I expected. Here are my thoughts on valuation.

I sold out all of my OLN and have covered about half of my GGC short. Normally, I would want to capture the additional downside that I foresee on GGC. However, I am being charged an enormous amount to borrow the stock.

I would not have covered if the huge spike rally at the open had continued all day, and I will probably reshort if it hits those levels again.

What I'm Doing Today

-Sold more GGC at 15.6.
-Adding capital to my short YRCW / long U.S. Freightways 8.5% note due Apr 2010 trade - see the 8-K they just filed about an exchange offer.
-Looking at adding capital to my short REG / long REG-E trade.

I need to write more about the YRCW trade. Also I am reviewing the third quarter REG earnings and conference call and I'll be posting about it later.

Regency Centers (REG) Reports Decline in Same Property NOI

I'm looking at the Regency Centers (REG) supplemental information release for third quarter 2009. For the quarter ended September 30, 2009, same property net operating income (NOI) declined 6.5%.

When I started talking about the REG/REG-E pair trade, I concluded that "my key disconnect with [RBC's bullish stance on REG was that] they expect NOI growth and I would consider them lucky just to maintain present levels."

So... NOI is dropping, just as a reasonable person would suspect. The key drivers of NOI are the rents and occupancy of their shopping centers. These are determined by the supply and demand for retail space. Supply increased during the credit bubble and demand is decreasing due to the crash.

Time to Add Capital to Regency Centers (REG) Pair Trade

The other big pair trade (besides GGC/OLN) that I am doing right now is the short REG, long REG-E trade.

This trade has been cleaning up too: REG is down 10.8% and REG-E is up 5.8% (chart). The spread really widened the past few days.

I am planning to add more capital to this trade, so I made a P&L matrix:

Assumes equal share amounts. I bolded the values that I think are likely outcomes. This trade is also nice because it has positive carry.

Today's Georgia Gulf Rally

Got some questions about the 6% rally in GGC today.

OLN was down 1.8%, so despite what I wrote about the pair after OLN's earnings yesterday, the spread widened.

There were a lot of junky stocks up today - I view the GGC move as a dead cat bounce after yesterday's 15% drop.

We will see tomorrow.

Looking for other capital structure arbitrages right now and not finding much. There are lots of bonds trading at 60 where it is a head-scratcher as to how they could recover anything.

Chemical Industry Watch: Georgia Gulf (GGC), Olin (OLN) and PPG Industries (PPG)

Georgia Gulf Corporation (GGC) will be releasing Q3 financial results on Wednesday, November 4, 2009 at 5:00 p.m. ET, with a conference call the next morning at 10:00 a.m. ET. Olin (OLN) announces earnings this Monday with a conference call on Tuesday.

The pair trade has been doing well. Since Oct 2, GGC is down 29% and OLN is down only 5%. I bought more OLN after the big dive it took today, having already shorted more GGC earlier this week.

I will be very curious to see the earnings results.

Competitor PPG Industries had their Q3 conference call last week. They were weighed down by their commodity chemicals operations (the segment that competes with GGC and OLN), which suffered a 43% y-o-y decrease in sales (page 7 of investor presentation). This was the result of big price and volume declines. Year to date chemicals sales were down 32%, meaning that the commodity chemicals decline picked up in the third quarter (segment sales comparisons).

On the conference call, PPG said that they do see the electrochemical unit (ECU) pricing improving a bit so far during the fourth quarter.

GGC also amended their registration statement again. This is the fourth amendment - they already amended it two days ago. Previously I speculated that their motive for these amendments was to stall the SEC from making the registration statement effective. However, I notice that this statement has an opinion from law firm Jones Day dated yesterday (Oct 22) regarding the validity of the new shares. So maybe they were just waiting for that?

I may make the chemical industry a focus area of investing - I am planning to go through a pile of chemical industry books when I get the chance.

Update on Georgia Gulf (GGC) and Olin (OLN) Pair Trade

GGC is now down 23% and OLN down less than 1% since I recommended the pair trade of short GGC and long OLN.

GGC has been falling on higher volume days, although the volume pales in comparison to the number of shares the bond funds would probably like to sell.

There has been no news on GGC - presumably just selling pressure from the new holders is moving the price.

Georgia Gulf (GGC) Closes Down 8.5%

All it took was some blocks of 10,000-20,000 shares, with total volume of only 200k.

Digging through management's Q2 earnings presentation, I find that my capital structure/enterprise value calculation for GGC did not include $14.9 million in other long term debt plus a Lease Financing Obligation of $96.3 million.

That extra burden moves my GGC equity valuation target down to $0. I am shorting with impunity since I own OLN and GGC bonds as a hedge.

If the new shareholders' selling does not take the price down, or if they don't sell, I would expect the company to issue reams of equity. It would be good to continue de-leveraging.

Georgia Gulf Corp (GGC) and Olin Corp (OLN) Pair Trade Idea

I have been meaning to post about this for months; here it is.

An extensive restructuring of Georgia Gulf Corporation (GGC $29) involving a distressed debt exchange, convertible preferred stock issuance, and a 25:1 reverse split has caused confusion and led to a huge mispricing of GGC equity. Enterprise value for GGC is 14x management’s estimated 2009 EBITDA versus ~5x for its closest competitor Olin Corp (OLN $16.50).

GGC is an Atlanta-based manufacturer of commodity chemicals and vinyl-based building and home improvement products.[1] The company operates in four segments, Chlorovinyls; Window and Door Profiles and Moldings Products; Outdoor Building Products; and Aromatics. It markets its vinyl-based building and home improvement products under the Royal Group brands.

In October 2006, GGC vertically integrated by buying Royal Group, a downstream consumer of chlorovinyls, for $1.6 billion, “transforming Georgia Gulf Corporation into one of the most highly-integrated companies in the residential repair, renovation, and remodeling markets.” The 2005 EBITDA for Royal Group was $224 million for a transaction multiple of 7.1x. This transaction was nearly the ruin of the company as the outdoor building products and window and door profiles and moldings products segments of the company have been performing worse than the commodity chemicals segments, and even had negative gross margins in the most recent quarter.

Olin Corporation is also a commodity Chlor-Alkali chemicals manufacturer, which represents 72% of 2008 sales, with the balance (28%) consisting of the fantastic Winchester ammunition business. This is a much better subsidiary to own than the vinyl-siding Royal Group. For one thing, ammunition is a nice oligopoly with almost all production owned by Olin, Alliant Techsystems (ATK), or Cerberus Capital Management (private). [2]

Also, OLN is better managed than GGC, judging by their decision to sell a subsidiary (Metals) to a New York private equity firm in 2007. (On the other hand, they did buy chemicals competitor Pioneer in 2007.)

What I like about this trade is that on their own, OLN is a good long, GGC is a great short, but they are so comparable that they also pair together well.

GGC Capital Structure
A key factor causing the current mispricing of GGC is confusion over its capital structure, thanks to the restructuring and reverse split. The current enterprise valuation is outlined below.


Only a small amount of the notes remain because 92% of them were tendered in July in exchange for stock. Note that Yahoo Finance and other data providers are wrong about the market cap and enterprise value of GGC. The structure I show here is derived from a recent 8-K.

Relative Valuation
GGC has a higher enterprise value than OLN, but lower gross profit, EBITDA, and cash flow. Additionally, OLN has a long history of paying dividends, and currently yields 4.9%.



GGC Valuation
Management has estimated that 2009 EBITDA for GGC will be $110 million. Stretching as far as a 8x multiple would leave only $347 million in value for common shareholders, putting the share price at $9.95, a 66% downside from today's levels. The table below shows value/share available given a number of possible EBITDA multiples. Note that the common GGC shares are a zero if the enterprise is valued based on OLN's current multiple.


GGC Recovery Analysis
Another interesting question is: where should the notes trade? This question is basically ignored by the market given that there are only $64 million notes outstanding now that the the exchange has been completed.

Given the current $986 million market cap of GGC, it is odd for the sub debt to be trading at 63, to yield over 20%. If the current equity pricing persists, I would expect the company to make a huge equity issuance and buy back debt. All of the notes have double-digit yields. They would probably find them the best ROI in the chemical industry right now.



The Trade
I like shorting GGC and buying OLN as a hedge. Also I like GGC debt as a hedge.

Notes
[1] Chlor Alkali refers to combination of chlorine (Cl) and caustic soda (NaOH), which are co-produced by the electrolysis of salt (NaCl). These co-products are produced simultaneously in a fixed ratio of 1 ton of chlorine to 1.1 tons of caustic soda. The industry refers to this as an Electrochemical Unit or ECU. As of YE 2008, OLN had a consolidated capacity of 1.91 million ECUs per year, making them the third largest chlor alkali producer.

[2] Olin, by virtue of its Winchester subsidiary, is the most attractive way to gain exposure to ammunition manufacturing. Remington is privately owned by hedge fund Cerberus. Alliant Techsystems, which owns the Federal and CCI/Spear brands, is not as attractively priced.