Chris Squared

October 19, 2016 12:39 AM


Recently, my good friends Chris Mayer and Chris MacIntosh "Chris Squared" had a chat on a number of topics that I feel strongly about. In particular, they chatted about how passive investing has created opportunities (more about this in the future) along with much more...

Click here for the conversation

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Crook vs. Jerk

September 4, 2016 12:51 AM


“For a country with over 300 million people, why do you choose such bad politicians?”

Yup, I’ve been doing business overseas for a while now and I keep getting the same question from foreigners who simply cannot decipher the American political system. Heck, I often ask myself the same questions.

A few years ago, I had this conversation;

Him: Will George W. Bush invade my country?

Me: Don’t worry, he can’t find it on the map...

Fast forward 8 years;

Him: Why is your Nobel Prize winning President starting wars with everyone, including a race war in America?

Me: Hell if I know. It’s embarrassing to all of us in America.

In all these exchanges, I can chuckle, drink my beer and proudly say that I didn’t vote for them. However, as I go through my daily rounds, this year’s election is just too dysfunctional to laugh at.

On one hand, we have the most corrupt person to ever run for President of the United States. From the Clinton Initiative slush fund financed with illegal dealings with corrupt overseas oligarchs and villains to the stonewalling of numerous federal investigators she continues to operate like some post-Soviet apparatchik. In order to deflect criticism of her past, she has incited a race war that is both disturbing and repulsive to all that America stands for. Her utter subjugation of the media is both shameful and astonishing. Google has changed its search ranking system, Twitter routinely censors her opponent’s supporters, and The New York Times has become a ministry of propaganda. Joseph Goebbels could only dream of the sort of power that she wields. Her methods are anathema to the American system of transparency, honesty and an independent press. With that said, I have to give her credit. Through 30 years of scandal, illicit dealings, and outright felonious behavior; she has remained remarkably untouchable, whereas a lesser politician would have been incarcerated long ago. Cold, shrewd, ruthless and calculated—lord knows, she wants the Presidency worse than anyone else alive. Her determination really is impressive.

Offsetting this criminality is quite possibly the biggest jerk on earth. As a guy growing up in New York, I remember that every society paper was filled with his endless feuds. Every business paper was full of his lawsuits and those who were counter-suing him. Abrasive, inconsiderate and offensive have been hallmarks of his self-promotion. Nothing is more humiliating than being fired before millions of viewers on television—yet, he reveled in that power. Now, on the national stage, he has taken this offensiveness to new levels by insulting whole countries. Does he have a filter? No, he actually enjoys the fight. Is he the image that America wants to project globally? Of course not.

And, as I sit on a patio and drink my beer, I have to explain this all to my foreign friends. I’ve tried to illuminate the nuances and dive into the details but in the end, this election is about two words—Crook vs. Jerk. America’s most notorious Crook is up against America’s most notorious Jerk. Who do you want running your country? Crook or Jerk?

Explained in those terms, most foreigners take a deep breath and come up with some version of the following, “We all look up to America and your desire for transparent and honest politicians. What separates my country, with its chaos, from yours is the fact that your politicians are honest.” To that, I laugh a bit because America has done a great job of brainwashing the world with its propaganda. Our career politicians are as corrupt as any banana republic’s, except ours usually steal in the name of the large corporations that finance them—as opposed to their own families. Only true outsiders from the political mainstream, those who’ve never been part of the system, can say that they’re not beholden to any special interest or corporation.

So, does Jerk beat Crook? Or does the Crook steal the election? Thankfully, I do most of my business overseas—I’ll survive no matter what the outcome is. As an American, I sure wish we had better choices, but I still have to explain this election to everyone I meet. Crook vs. Jerk sums it up. To most of my friends, mired in corrupt and dysfunctional systems, America is a beacon of hope. Too bad it seems as though Crook is leading in the polls.

election 2

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Chris Calls Kuppy

July 30, 2016 5:28 AM


Two weeks ago, I had a call (linked below) with my good friend Chris MacIntosh from Capitalist Exploits. We spoke about Brexit, Bitcoin and why my investing strategy has evolved from buying small growing companies to buying the shake-outs from macro events. I recommend subscribing to Capitalist Exploits in order to get notified when new content is posted.

Trading Chaos

Trading The Chaos

https://capitalistexploits.at/2016/07/conversations-with-harris-kupperman/

 

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A Crisis In Ponzi-Land (The "Drop-Down")

February 25, 2016 1:21 AM


As I dig through the toxic debris of collapsed Ponzi-Land MLP vehicles, I keep having this recurring question; why do all these MLPs continue to have sponsors that are so aggressive in supporting the LP distributions? I’ve seen everything from; purchases of preferreds at below market interest rates, to sponsors agreeing to forgo subordinated distributions, to support agreements where they are literally gifting the MLP cash to offset its SG&A expense and maintain enough cash flow to cover its 1.0 Distributable Cash Flow (DCF) to LPs. I’m all for charity, but since when do PE funds gift public shareholders cash that they can then receive in distributions? This doesn’t seem like finance as I know it—the stock market exists to screw suckers, not enrich them. Finally, it all came together for me—these bastards have been greedy twice and they’re still screwing the LPs while trying to look generous.

I’ve already gone over the twisted incentives of IDRs—now let’s talk about the “drop-down.” The premise of a "drop-down" is that a stabilized asset is sold by the sponsor to the MLP and due to differences in yield expectations, the sponsor is willing to cash out at a higher yield than the current cost of debt  at the MLP, leading to accretion to LPs. It’s simple cap-rate arbitrage and since public vehicles often carry higher leverage ratios, it lets more leverage be employed to increase returns.

Previously, the “drop-down” always seemed like it was the true scam, designed to feed the IDR math and de-risk the return for the sponsor as the increased financial leverage was now at the LP instead of GP level. Then I realized; the gain on sale might actually be leading the whole process at MLPs. It’s easy to look at some of the drilling sponsors, see what they paid for the rig, what they dropped it down for and have a good chuckle—crafty Norwegians—they understand financial engineering with the best of them. Most transactions don’t leave such an obvious paper trail, yet as I’ve discovered, the stated ROA is the give-away that something is indeed fishy.

ponzi 4

Take a midstream gathering asset. It costs $50 million to build and produces $15 million in annual DCF or a 30% return—not bad. At a 10% disposition yield, it is worth $150 million. Sell it to the MLP for $150 million and voila, you have a $100 million gain on sale. The MLP borrows $150 million on the revolver at 5% and then has $7.5 million in incremental DCF with no dilution. Talk about successful financial engineering. At the LP level, it looks like the sponsor has done the LPs a favor by creating extra DCF and the press release can brag that there has been NO DILUTION, only an increase in the distribution—which makes shareholders happy—even if a good chunk of that goes back to the sponsor through the IDR.

Now look beneath the numbers a bit, the sponsor has taken all the real gains and the MLP has taken all the risk. The sponsor got a $100 million gain on sale along with an increase in the IDR. The MLP got an incremental $7.5 million of DCF with leakage through the IDR and now has $150 million of additional debt. That’s a very un-equal bargain. Meanwhile, in the 20 years that it takes to pay off the debt through DCF, the energy field has probably been depleted to the point that the midstream asset is stranded and practically worthless. It’s Ponzi-finance at its apex.  

As I search through dozens of these companies, I’m amazed at just how many of their assets seem to be earning better than 20% ROA with a massive offsetting dose of goodwill—effectively equaling the profits to the sponsors. In addition, depending on how the purchase accounting was resolved, this may also explain the huge mismatch between depreciation and DCF. In the end, the MLP is often the dumping ground for overpriced assets which are increasingly becoming stranded uncompetitive assets as volumes trail off and competing infrastructure is built. At 20% un-leveraged returns, you would expect a lot of competition and rapid margin compression—it just takes a few years to show up. It would seem that the sponsors keep the MLP lights on because there is no other way to extract huge gain on sale profits on rapidly depreciating assets—except to dump them on sucker MLP investors. They can’t even sell them to other MLPs because those MLPs have their own backlog of sponsor assets to “drop down.”

ponzi 6

In the 2014 vintage of MLP presentations, I repeatedly see this slide presenting future distribution growth in the form of an inventory of “future drop-downs from the sponsor.” The basic premise was that the distribution can grow forever because the sponsor has more assets that they’ll sell you. Back in 2014, that slide got the MLPs a growth multiple—today it is all quite hilarious. They were making so much money looting the LPs that they even had the gumption to brag about all the crap they were going to plug them with.

In 1998-2001 an epic glut of fiber optics was laid that bankrupted everyone who funded it. Over the past few years, the same thing has been repeated with midstream gathering assets. Much like fiber optics, the assets have value, just nowhere near what people were tricked into thinking they did. The big difference is that since the tech bubble, the promoters have matured and developed new and creative ways to screw investors.

Despite dropping 90%, many of these MLPs are not cheap. Rather, they're going to zero—in the meantime, sponsors are going to do everything possible to keep the game alive—it isn’t altruism that is supporting these companies.

Be VERY skeptical.

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A Crisis In Ponzi-Land (Cut The Dividends Already!!!)

February 17, 2016 2:34 AM


Until early this summer, certain promoters seemed to believe that they could do a magic trick that no one would catch. A larger entity would “drop down” an asset at twice what it cost to purchase or build, add a bit more leverage and call it a “yield vehicle” that would then be sold to retail investors. Adding hubris to this whole charade of financial engineering, the “sponsor” would keep an IDR so that in addition to a huge gain-on-sale, it would also get a healthy chunk of the cash flow from this “yield vehicle.” Is it any wonder that in a market starved for yield, these vehicles frequently traded with dividend yields of 8%-10%? Even retail investors weren’t totally fooled. However, the yield was the inducement to allow these vehicles to continue raising equity (see Part I).

Six months later and there are no fools left. Many of these MLPs now trade with yields well over 20%. At 8%, an investor gets intrigued—at 10%, it gets more interesting. When it pushes into the 20% range, it is no longer interesting—it is scary. Even if the numbers check out, you ask yourself, “What am I missing?” The yield was the inducement to lure in retail investors, now the yield is pushing them further away. Before, it brought in more equity capital, now it is simply bleeding capital that will be needed in the future. When you are leveraged by 4 or more times EBITDA, even a small decline in revenue can create a major solvency issue—especially when your customers are in the energy sector. Yet instead of paying down debt, these companies continue to fund ridiculous dividend yields.

The lynchpin of this conundrum are the Incentive Distribution Rights (IDRs) that are held by the “sponsor” GP. These IDRs produce huge cash flows for the people who were crafty enough to build “yield vehicles” in the first place. No one wants to give up on the IDR, especially if the cash flow from the IDR is needed to service GP level debt or the GP is partially public. (I think it’s particularly ingenious that sponsors were able to borrow and sell equity against future siphoning from “yield vehicles”).

MLP1

In any good host-parasite relationship, the parasite is careful not to kill off the host. At this point in the cycle, the IDR is killing off the host. Much like in nature, I think that the GP will have to relent a bit, but the GP will also come out ahead long-term. Wouldn’t it be better for everyone if the MLP pays no dividends for a few years and instead engages in aggressive buybacks of shares and bonds that often trade at huge discounts to par? In that case, the host will de-lever the balance sheet and very accretively reduce the share count as most of these things trade at obscenely low EBITDA multiples. The GP will get crushed in the short term, but the GP then benefits substantially in the future as there will be much more cash flow per share, leading to much higher potential payouts through the IDR. Alternatively, the IDR can be merged with the MLP as we’ve seen on a number of occasions by promoters who realize that the game is over and they ought to salvage something of IDR value before it is too late.

Now, I’m sure that some of these MLPs really can support the current dividends—but that has stopped mattering as yields go past the teens. Besides, why pay out a double digit yield when you can do something very accretive for everyone involved?If nothing else, reducing leverage and retaining capital will de-risk things and set you up to buy out failing MLPs who refused to cut.

The smart players will realize this next step in financial engineering and the greedy ones will bankrupt both the IDR and MLP. When you trade at over 20% yields, it is time to cut the dividend—watch for the companies that do this. There are huge bargains to be had in the debris of Ponzi-Land, starting with the MLPs today and the GPs with IDRs a few years into the future. Let’s just say that I haven’t slept much in 3 weeks. For the first time in ages, there are some pretty stunning bargains to be had and I’m getting educated fast and scooping them up.

The toxic debris of Ponzi-Land will be a recurring topic for quite some time. Interestingly, the trade will be pretty straight-forward—don’t buy until the day that the dividend is cut dramatically enough to spook the last few yield guys, then get greedy if it’s cheap. If they’ve already collapsed the GP into the MLP, overweight the position.

 

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