Ready, AIM, Sell??

June 13, 2017 9:06 AM


I have spent much of my career looking for strong macro trends that will drive the performance of individual companies. However, over the past few years, I’ve had much more success buying overreactions to bad news, as the makeup of the market has changed and short-term thinking pervades investment decisions. Often, large fund holders sell without even understanding what the news means. Instead, they’re more concerned with showing their investors that they didn’t own a stock that’s down 80%--especially if it’s a well-known company amongst their investor base. Meanwhile, when in sell mode, future bad news is all colored bad and good news is ignored—then the indexes kick you out and more selling comes on top. It’s just a pile-on. On the flip-side, the move from down 80% to even just down 60% is a doubling of the share price and it often happens rapidly when the selling ends. With that in mind, I might as well tell you why I own so much Aimia Inc (AIM – Canada).

Aimia operates and owns loyalty programs. It’s a reasonably good business, in that their partners buy points that Aimia creates. Aimia then give those points to their loyalty members and then at some later date, those members redeem the points for rewards such as free travel or gift cards. In the interim, Aimia has “float” from the cash that’s been paid for points that have yet to be redeemed. Additionally, a healthy percentage of points are never redeemed and Aimia gets to keep that “breakage” as free profit. Over the last few years, the sector has gotten rather saturated, which has somewhat reduced the value of individual programs, but it’s still a good business—even if it is one that’s in slow decline.

aim chart

In any case, I’m not so fixated on the long-term business fundamentals, as I am on the reason that shares of Aimia declined 80% last month. On May 11, Aimia was notified by Air Canada that they would not be renewing their current relationship after it expires in 2020. Canadians, assumed that this was the end of Aimia as Aeroplan is the largest loyalty program managed by Aimia and Aeroplan with its 5 million members, ranks up there with Tim Hortons and maple syrup in the Canadian psyche. As Aeroplan was itself a spin-out from Air Canada, it was assumed by most Canadians that Air Canada was the entirety of Aimia. What these panicked shareholders have failed to understand is that Air Canada represents approximately 11% of the total points purchased at Aimia and while it is the largest redemption partner for points (loyalty members prefer airfare to other options), this spending power can be re-directed in other places where current and future redemption partners are desperate for the $600 to 700 million in spend that comes from Aeroplan. Even more ridiculously, this change with Air Canada doesn’t occur for three years. During that time, Aeroplan will earn enough to pay off all of its debt and dividend almost the entire market cap out in dividends. In fact, the company is going ex-dividend for the first of those quarterly dividends, representing 10% of the share price on Wednesday the 14th.

A lot will happen between today and June 2020 when Air Canada parts ways with Aeroplan. I think it’s likely that longer term, this is good news for Aeroplan (despite what you read in the financial press) as it diversifies Aeroplan redemption options and allows Aeroplan to direct redemptions towards higher margin options. In any case, it’s highly unlikely that I’ll still own the shares as this all plays out. For me, this is a short-term sort of trade where I’m looking for a bounce from a ridiculously oversold condition.

aeroplan

The shares trade at 1.5x current year’s cash-flow guidance and a 40% dividend yield. While there is always risk to any business—especially one in transition, this business has many other components that are doing well. Aimia has huge value in its half ownership of AeroMexico’s PLM program (likely worth about the same as the current enterprise value), along with many existing point purchasing partners for Aeroplan. I expect that point purchases will decline and redemptions will increase over the next three years as loyalty members leave the Aeroplan network. It seems likely that current guidance of $220 million in cash flow is unrealistic, but the magnitude of the miss is hard to guess at. My hunch is that the miss isn’t all that substantial, but without new guidance, it’s just easier for everyone to sell, rather than think it all through.

Basically, I don’t understand how a change that takes place in 3 years, should yield a company with a $300 million market cap if there is $556 million in cash and liquid investments, with only $450 million in debt, while the company will earn $220 million (guidance) for the next 3 years. Even if they miss the number badly, there’s still a huge margin of safety here. That is before considering the other programs outside of Aeroplan that are likely worth more than the entire enterprise value. There has been talk in the media of an increase in redemptions hitting liquidity—I’m sure that’s happening to some extent and the redemption liability is a true liability, but the increased pace of redemptions is not enough to impair the company. In summary, in a situation with limited transparency in earnings over the next few years, along with a change-over in the C-suite, most investors have chosen to sell—rather than actually evaluate the situation. Aimia is simply cheap and you get paid 40% a year to wait for others to realize this fact.

 

 

Disclosure: Funds that I manage are long Aimia (AIM – Canada)

Categories: Current Investments
Positions Mentioned: AIM CN
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Re-Reinventing The Death Spiral

May 31, 2017 5:40 PM


On April 9, I wrote about how certain companies have death spiral financings in place and you could literally short them at will for almost risk free returns. Now, barely 7 weeks later, Dryships Inc (DRYS – USA) is already down by 90% since I wrote that piece. I’ve been shorting DRYS and a few others like it for quite some time and re-loading as the position size declined—hence my returns have been even better than that 90% return. However, based on last Friday’s update, the balance sheet is now;

$220.6 million of cash

$413.7 million of vessels

$200 million of debt

Net book value of $434.3 million.

With 13.778 million shares outstanding, net tangible book value per share is $31.52 and DRYS closed at $2.38, or 7.6% of tangible book value. Additionally, DRYS is likely cash flow positive with the recent vessel deliveries.

This all got me thinking; how would someone with plenty of cash, who controls this situation and has a total disregard for shareholder interests, play his hand? Is it better to dilute shareholders by continuing to raise $4 to $6 million a week that you can abscond with through related party transactions? Or is it better to end the Kalani program through one last large sale to yourself for $50 million worth of shares at $1.00 and effectively own 78% of the company at 3 cents on the dollar of asset value?

The first method will get you additional cash to siphon off, if new buyers continue to show up to get diluted—a questionable assumption based on the rapidly declining pace of recent equity sales—in fact, I wouldn’t be surprised if equity sales trickle to under $50 million of annual run-rate very soon. Isn’t the smarter move at this point, to get a disproportionately large percentage of the $434.3 million of book value at a cost of roughly 3 cents on the dollar and then control a collection of assets for almost no net capital after a 1-time special dividend? That then gives you the most optionality for the next stage of your schemes.

I don’t know which direction this goes, but the recent loan committments, the decline in the rate of share sales and the ridiculous discount to current book value, have convinced me to cover my position and move on. Let’s just say that there are some guys in Greece who are very entrepreneurial with their capital structuring and I wouldn’t be surprised if someone re-reinvented the death spiral by inverting it and grabbing the assets for his own advantage--especially as he controls the price of the shares and the issuances of equity. Hence, it is time to move on and declare victory. In any case, after the past few months of very profitably shorting these death spirals, I’ll always have a warm spot in my heart for unscrupulous Greek shipping magnates.  

Categories: Current Investments
Positions Mentioned: none
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Reinventing The Death Spiral

April 9, 2017 11:47 PM


About two decades ago, some unscrupulous hedge funds began tricking unsophisticated small cap companies into agreeing to “death spiral” converts (convertible debt). These were called “death spirals” as there was no set floor to the conversion price. Rather, they converted at some date in the future based on then market prices. Despite promising not to, these funds immediately began shorting shares with the goal of destroying the share price and converting as low as possible in order to take control of the companies, or at least get large share ownership positions. Oftentimes, a few million dollar “death spiral” convert would end up costing management the majority of their company. Along the way, my fund sometimes shorted these “death spiral” stocks as you knew that the hedge fund owning the paper would keep leaning into it until the conversion date. Furthermore, any intelligent long would sell and move on—as you just can’t do business with someone too stupid to not understand how these things worked. Without logical buyers and a wall of stock on the offer, they were as close to layups as you could get in finance.

Since then, corporate boards have wised up and you seldom see these “death spirals” any longer. Of course, in finance, there are rarely new inventions—rather, creative finance types dust off old tricks and re-imagine them. Therefore, you have to have a certain respect for CEO George Economou from Dryships Inc (DRYS: Nasdaq) as he took the “death spiral” and added a unique spin to it. In the Economou version, he “death spirals” his own stock through an independent party named Kalani. DRYS has now undertaken a few variations of this theme, but the basic underlying trend is that DRYS sells shares to Kalani at a discount to market and Kalani then sells them into the market as rapidly as possible so that Kalani can reload and earn the spread between the price they buy them from DRYS at and what they can sell them for. In the process, the share price of DRYS has been in freefall.

DRYS

Now, you have to be asking the question; why would Economou want to purposefully crash his share price? I don’t think he cares what happens to the share price, beyond propping it up sufficiently to sell more shares. His goal is to load DRYS up with cash from the share sales so that his private entities can extract value through fees and asset sales to DRYS at inflated values. It’s a unique spin on the host-parasite relationship.

Of course, the next obvious question is; who the hell keeps buying this stock if you know that he’s going to keep reloading for a few hundred million dollars in share sales each quarter? Now, here’s where you have to admire Economou, while I’m sure some poor retail guys haven’t read the fine print and got thoroughly abused, my hunch is that most of the buying is coming from various quant funds. You see, these funds are run by computers and they look for underlying fundamental values like; price to NAV, price to cash flow, revenue growth and cash flow growth. These computers aren’t yet smart enough to read the fine print and understand what Kalani is doing—in fact, the various Kalani deals do not look all that different from an equity line of credit, convertible bond or at-the-market offering. Optically speaking, DRYS trades at an obscene discount to NAV and revenue is growing as is cash flow. The computers are short-circuiting themselves to buy this thing as it looks cheap. Even crazier is the lag between when the share sales happen and when they’re reported. If you were buying on Friday, you would have thought that the share count was around 152 million—nope, 36 million shares were sold since the last reported share count and the new share count is 188 million. The computers are using the wrong data inputs as they’re programmed to assume that a company is trying to create shareholder value or at least not destroy it on purpose. Economou’s trick is to sell shares at such obscenely cheap values that it continues suckering new buyers into DRYS shares.

In finance, no lucrative scheme can go on for long before imitators show up. Since DRYS started its “death spiral”, Diana Containerships, Inc. (DCIX: Nasdaq) announced their own version of the “death spiral” using warrants. I’m sure others will follow. I bring this all up because no one should lose money for not reading the fine print—if you own either of these, be wary. Never simply assume that management cares about you as a shareholder. Much more importantly as more “death spirals” are created, there are lots of opportunities to profit on the short side. I don’t normally short stocks, but in these situations that are designed to fail, I cannot help myself. I’m playing small and expecting some epic short squeezes along the way.

I suspect that shorting these "death spirals" will continue to be a lucrative little venture over the next few quarters. Please share with me if you see any new death spirals announced.

Bombs away!!!

Disclosure: I am short DRYS and DCIX.

Categories: Current Investments
Positions Mentioned: none
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Hasta Luego Mexican REITs

March 9, 2017 1:27 AM


Him: I think people are wrong. There are lots of instances where the Fed has raised rates and nothing bad has happened.

Me: Name one time.

Him: hmmm…. Oh crap!!

Yea, we’re getting to that moment where people realize that rates may finally matter in a highly leveraged economy. My good friend Tal, made that point over a year ago.  I hope you took his warning and lightened up on interest rate sensitive assets.

Let’s think of a typical REIT called Ponzi REIT (Ticker symbol PREIT). They’ve been out there for nearly a decade, buying “irreplaceable” Class A assets in “gateway cities.” Every six months, they raise money to buy more assets and through a combination of financial engineering and deferred maintenance, they manage to increase incremental AFFO per share on each transaction. So what if they’re overpaying--buying 4-cap assets if they can fund them at a 3% financing cost—it’s still accretive to the dividend.

Ignoring working capital and taxes, the current balance sheet is $10 billion in assets at cost offset by $5.5 billion in debt for total debt to capital of 55%. So far, it looks like pretty much every property REIT out there. At a 4 yield, they have $400 million of operating income and $165 million of interest expense, for total AFFO of $235 million. They trade at a 4% dividend yield or a $5.875 billion market cap. By magic, $4.5 billion of equity is worth 31% more than book. We’ve covered this before in my section on Ponzi MLPs last year. As always, it’s highly lucrative for investors to continue this charade with future capital raises, until it isn’t.

Now, interest rates are rising. Let’s say that PREIT’s assets are no longer valued by the market as 4-caps, but are instead 6-caps. Keep in mind that this would still be dramatically below average cap rates over the past few decades. Now, the $400 million in operating income is only worth $6.667 billion and with $5.5 billion in debt, total debt to capital is 83%. That’s a VERY leveraged balance sheet. Even worse, the assets are funded with 5-year paper. When that re-sets to 5% interest rates, interest expense bumps up to $275 million a year and AFFO declines to $125 million a year. At a new market 6% dividend yield, this is now only worth $2.08 billion. Essentially, a small change in interest rates just destroyed 65% of the equity value of PREIT.

All of this assumes that the revenues at PREIT stay the same. What if rents decline? It’s no secret that there’s a massive oversupply of commercial property being built. If rents or occupancy decline, you could be looking at a situation where dividends could be cut. Heck, interest coverage itself may come into doubt. I know that lots of investors keep talking about interest rates not mattering in the property sector because rents will go up with a stronger economy. Rents will need to go up a whole lot to keep pace with cap rates going from 4 to 6. We all know that isn’t going to happen. Especially in sectors like retail where tenants are increasingly downsizing. Finally, REITs are unusually bad vehicles for dealing with debt re-payment when the ponzi scheme goes in reverse as REITs cannot retain earnings to de-lever and instead must raise capital by issuing equity--often at highly disadvantageous prices. At least MLPs were able to cut dividends and de-lever. Look at 20 year charts of many large REITs. Notice how long it took them to recover from the highly dilutive equity raises that most undertook in 2008 and 2009.

Of course, I’m not the first guy doing this math. Look at the charts of various smaller REITs that aren’t being propped up with broad market ETF inflows. These things are getting nuked—particularly in the retail sector. I suspect that this contagion eventually spreads to other REITs as well. Where will they bottom? My guess is a whole lot lower and this will put stress on many other sectors of the economy. For instance, it is still a head scratcher why banks have recently been so strong, as they will bear the brunt of this decline in asset values.

I continue to have very few long positions and continue to wait for bargains. As I survey what few positions I have, I realize that I don’t want property assets—even if they’re dramatically undervalued and underleveraged Mexican hotel REITs that will benefit from a weaker Peso. If REIT investors start to liquidate assets, nothing will be immune. Over the past few days, I’ve sold the majority of my positions in my 2 Mexican REITs for roughly 10% gains after accounting for an appreciation of the Peso. I think these are good long-term holds, but I’m waiting for more of a crack-up before wading back into anything property related. I have a feeling that I’ll be increasingly active in busted property REITs at some point in the future. For now, they mostly look like the Ponzi MLPs that I wrote about last year. Guess it’s time to start educating myself on a few of them.

Categories: Current Investments
Positions Mentioned: none
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NZME

February 26, 2017 5:23 PM


As I scour the world for opportunity, I’m usually looking at macro themes or misplaced pessimism or some other reason for an asset’s current undervaluation with an eventual catalyst. Sometimes, in that process, I simply stumble upon something that is unusually cheap. Normally I choose not to write about these, because being cheap tends to be boring—especially if there’s no added story. After some urging from friends, I intend to write about more of these situations. As always, the hard analytical work is up to you—I’m merely the messenger regarding the situation.

NZME LTD (NZM: Australia) is one of New Zealand’s largest media conglomerates, operating in print, radio and online. In a typical day, by 9am 73% of New Zealanders have engaged with NZME in some way. Every investor hates print newspapers, but New Zealand is somewhat insulated from the forces that have destroyed US papers as there just aren’t that many other options to get domestic news—especially regional news—as opposed to the tens of thousands of options in the US. As a result, while print subscriptions are declining, overall readership is increasing due to online penetration—leading to a slow decline in revenue with a more constant overall EBIT profile. Meanwhile, radio has been more constant, adjusting for some recent volatility in how sales were organized. I expect other business segments to have a negligible impact on the consolidated business. Overall, I don’t expect anything particularly momentous for this business. Results will probably range between meh and bleh, with a focus on cost cutting to offset future revenue declines—which likely leads to rather stable EBIT. In the end, advertisers in New Zealand have a rather constant annual marketing budget and there are only so many channels to push it through. Given NZME’s market penetration, it’s likely to absorb a roughly constant percentage of this revenue over time.

In summary, this is a somewhat boring cash cow which wouldn’t get my attention except for four unique facts. To start with, at Friday’s closing price of AUD $0.66, the shares change hands at roughly four times cash flow. The company reported earnings on Friday and I was pleasantly surprised at the results. I even bought a few more and I almost never pay up above my cost basis. Secondly, studies have shown that spin-offs tend to out-perform the market both for share-price performance and for operating performance in their first few years. This is because new management has greater control of resource allocation and decision making once removed from the parent. Thirdly, now that the spin-off has completed, the company has increased its dividend and the shares are now trading at a 14.4% dividend yield. 6 cents of that dividend will be paid to you in about 6 weeks, which reduces your total cost basis by almost 9%. With its high dividend yield, NZME is likely to be noticed by an increased investor base whereas the prior dividend rate didn’t scan well. Finally, NZME is in talks with Fairfax NZ over a highly accretive merger. Regulators have issued a preliminary decision to decline this merger over fears of market share dominance. I suspect that their final decision will be the same. However, if they agree to go ahead, the shares are worth a few times today’s quote. Otherwise, I don’t see why NZME with its low financial leverage and high payout ratio, cannot trade for around 10 times cash flow, or more than a double from today’s prices, while paying you a dividend while you wait.

Disclosure: Long NZM AU

Categories: Current Investments
Positions Mentioned: none
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