When one invests as an outside, passive, minority investor there are two prinicipal considerations the investor must make:-
1 The quality of the investment
2 The price of the investment relative to your estimate of intrinsic value
The further out you are of the company, the more concerned you are with quality.
The closer you are to the company, e.g. an inside investor or an activist investor, the more important price becomes to the equation. This is because you have more detailed or timely knowledge, or you can act as a catalyst to unravel the value that exists in that company.
Another factor, is of course, the financial position of the client. For example, this can affect how long you can wait for the investment to work out.
The emphasis must always be in using public information and clever investigation that any well respected analyst can do, but doing superior anaysis and knowing when we are out of our circle of competence. This will generally limit us to a few sectors where we build deep understanding and so we can more easily spot opportunities by analysing more companies per unit of time.
If one has a long term investment horizon, companies that dont have an immediate catalyst but are very cheap and slightly lower qualitym may be considered by the outside, minority, passive investor. However, only if plenty of data is available for many years and physical data measurements can be made in terms of volume, production capacity etc to verify the accounts, and this data can be verified by independent parties.
If one has limited time or knowledge to analysis in great depth the companies under investigation, then diversification can compensate for a lack of knowledge. Buying deep out of the money put options when interestingly priced is another means.
However, for one with deep knowledge of a company, and who by concentrating their portfolio may achieve control to the extent they can form their own catalyst, it makes sense to have a more concentrated portfolio. This investor generally has strong know-how and know-who, and large financial resources. For example, it makes more sense for the founder of a company to have a large portion of their wealth in their company, then a builder who notices the company on the pink sheets. The founder has considerably more knowledge on the company and the sector, hence is better able to make a good decision. They also have timely knowledge on competitors.
One must always examine odds, and consequences.
Wednesday 22 June 2011
Sunday 19 June 2011
A word about confidence....Greece
Greece has a budget and trade deficit. This means the government and the people of the country, in general, must borrow to maintain their quality of life, as they spend more then they earn. This means the country is dependent on foreign parties supplying capital to maintain their quality of life. This was expected to continue unless the Greeks (1) spend less, (2) sell more, (3) both. When one depends on foreign funds to live your daily life, in my opinion, you do not control your future anymore. In recent months we have all been made aware that the supply of capital from external parties to Greece is drying up. Hence the country is forced to aggressively apply one, or all, of the above mentioned points.
Cutting costs (reduce spending) is an evident way of showing the people in a country that their quality of life is being reduced. Hence, it is often meet with social unrest. The deeper the cuts, the larger the backlash. Rather then phasing budget cuts slowly over a number of years to responsibly manage the economy when capital was available in the market for Greece, bail out funds have been received from European governments that want to see the money returned quickly, so that they do not receive public backlash at home for their actions. The budget cuts are therefore deeper and must be orchestrated over a considerably shorter period of time. This means shock treatment for the Greeks, which is always extremely uncomfortable. Since EU country governments are voted into power by the national population, they are more likely to follow policies that are for the national interest, not Europe’s. Hence Greece received several billions in Q2 2010 to meet conditions that they must affectively reduce 10% of its GDP in two years. Of course it will not be achieved without a near civil war. However, at that time markets rallied and the Euro strengthened. We believe that leveraged companies or countries don’t get out of trouble by cutting costs only. They must invest in new initiatives that can generate future income to meet obligations and generate future prosperity. This is an incentive for people to work, and gives confidence to foreign investors so more capital becomes available if projects are developing positively. This is only achieved by receiving fresh capital injections and seeing that capital deployed productively. In the past this was achieved in Greece by devaluing its currency. With the country now using the common currency that is the euro, it cannot apply this strategy anymore.
Selling more means more work in the same unit of time (increased productivity) or simply working more hours. This also reduces quality of life as it generally means working harder and for longer. However, if done well, financial compensation need not be reduced and unemployment rates may not have to increase harshly. However, the question is what do the Greeks sell? Since they primarily deal with agricultural goods and low to medium quality industrial goods, they compete very heavily on price. Since they sell primarily to countries that use the same currency, they must either become more productive or wages must fall to become more competitive and generate higher returns on capital, which can attract fresh capital into the country. As mentioned above, in the past this was achieved by devaluing the currency, a more socially accepted practice to make the country competitive.
When a country is dramatically cutting costs (the public and private sector), all economic participants spend/invest less due to increased uncertainty and unemployment rates, and no new money is coming into the country, there is effectively less wealth in the country as assets prices are declining and the incoming cash flow is being reduced. This means the government is also receiving less tax income, reducing further its creditability and strength. Countries within the EU have also forsaken the ability to print their own currency, a privilege now held only by the ECB. Governments can only ask to borrow more money in the market. When a country reaches the stage Greece is in, this door becomes firmly closed.
As a result the Government of Greece received a bail out package from the European Union countries and the IMF under some very extreme conditions in Q2 of 2010. Furthermore, the Greek banks can only receive funding from the ECB as no other party accepts Greek bonds as collateral for loans.
Because of the extreme cuts required to receive the bailout package, unemployment will rise in Greece. This will encourage less spending, hence the government receives less tax as less business is being conducted. This forces the country to need to borrow more. Hence cutting costs whilst not receiving the benefits from these savings (i.e. used to pay interest payments), or new capital from abroad to invest in the country, will lead to a reduction in GDP. This will lead to more Greeks defaulting on bank loans. This forces the banks to need to raise capital. But the market is not welling to inject new equity into Greek banks at the moment due to the lack of clarity in what will happen. Hence the only funding avenue for Greek banks is the ECB. A lack of confidence in a country is a vicious circle.
So European countries should inject more money into Greece? But the voters in the European countries ask why should they help a country that overspent and did not work hard enough to overcome their problems when they were manageable? Other European countries are also suffering various degrees of discomfort due to a weak economic environment in developing countries in general.
So let the country suffer and pick itself up alone? Why should a single country affect the sustainability of a currency for several economies much larger then Greece’s?
This is a good question. The answer is the financial market in Europe is considerably more advanced in being “Europeanised” then a common European labour market, fiscal policy or language. French banks hold Greek bonds and German banks hold Portuguese debt etc etc. If Greece was to say they could not redeem their debt because they don’t have the cash, then banks around Europe will have to make write downs of several tens of billions of Euros. This would require a number of banks to raise capital, likely creating pressure in European equity markets. Furthermore, Euribor rates would most likely increase as interbank lending costs increase due to a lack of trust amongst banks on who held Greek debt and who would have to make the highest write down and how it could affect their solvency. Europe contains many leveraged economies and increasing the cost of a loan would likely boost default rates if they stayed high for too long.
But again, Greece is such a small economy relative to the EU, the European banking sector could absorb the write downs – only a few aggressive hedge funds would go bust.
However, the real fright comes when you look into the details. The ECB cannot fund the Greek banks if the government defaults on the debt. If Greek business people see their government default on Greek debt: they know the biggest holders are Greek banks and that these financial institutions now have no sources of funding: Greek money will be pouring out of Greek banks into German bank accounts in a last dash attempt to preserve their wealth before their banks collapse. However, governemtns are well trained in such affairs. Capital will be refused to leave the country, as was most recently done in another European country, Iceland. When external capital is not available for banks, deposits are there only source of funding and governments will try to keep them there at whatever cost.
The question is, how will other “weak European economy business people” react if they see that happen in Greece? Will we see large cash movements out from Spanish and Portuguese banks to German banks? Of course we will! Hence, suddenly, there really isn’t a single Europe! Capital cannot move freely around Europe! There is only Germany and a few select others. The market will make that happen. If the politicians don’t throw out the weaker economies by letting one default, the market will probably do that job for them very quickly…
The weak European countries will become like sieves: capital will not be retained in them – what goes in will come out as a result of a total loss of confidence.
Now that is what we envision happen if Greece does not redeem their bonds by taking that decision themselves. There has been discussion of having a voluntary roll over of debt so that a technical default does not occur and hence the Greek banks can continue to receive ECB funding and the Greek government do not need to meet their immediate financial liabilities. But how does this solve their problems? They still have no new capital coming into the country to help rebuild the economy! Hence it is simply being kept afloat! They must create liquidity from the assets they have. This means forced privatizations. But with the economy so weak, these assets would be sold at below normal market condition prices. But this is the price Greece will have to pay. There must be wealth destruction. It can come from a number of ways including defaulting on debt, selling their assets at a cheap price or wages falling (as it cannot come from a devaluing currency anymore). Funds from these savings can be used to reduce their debt load. When this is reduced, new capital from the markets may start coming in.
Wealth destruction is the procedure of removing the money that should have never existed, because it was poorly invested in the recent past. The mis allocation of capital always leads to an eventual reduction of the total capital in the world, as it has not been wisely deployed to increase its size. This would reduce the wealth of the country and hence the quality of life of its inhabitants. How will Europeans react to this? This is a question we do not know how to answer.
But what about the Euro?
If several weaker European countries are made to become “economic sieves”, this would scare foreign investors and likely lead to a sharp reduction in the valuation of the Euro. However, this is only likely to happen in the unlikely event that Greece decides not to pay its debt.
What if the rollover happens, how would the other “weaker countries react?”
“Same as usual.” “Just keep on going and wait for something to change?”
Probably.
An external catalyst seems to be required to start the wealth destruction process. In a capitalist system, this is the most efficient way to allow unsustainable countries, or companies, to start again in less onerous terms.
Another alternative is that the ECB starts printing more money to fund the weaker economies. This is "a la USA", hence would probably lead the Euro to display a pricing behaviour we have seen recently for the USD. However, Germany is very much against this solution and the ECB has so far positioned itself with a similar stance, even if it has bought many billions of government bonds already....
Indeed, one could day that the bailouts are a way of making it easier to have political, fiscal and economic union. Creditors will become the "equity" owners of these countries....
Cutting costs (reduce spending) is an evident way of showing the people in a country that their quality of life is being reduced. Hence, it is often meet with social unrest. The deeper the cuts, the larger the backlash. Rather then phasing budget cuts slowly over a number of years to responsibly manage the economy when capital was available in the market for Greece, bail out funds have been received from European governments that want to see the money returned quickly, so that they do not receive public backlash at home for their actions. The budget cuts are therefore deeper and must be orchestrated over a considerably shorter period of time. This means shock treatment for the Greeks, which is always extremely uncomfortable. Since EU country governments are voted into power by the national population, they are more likely to follow policies that are for the national interest, not Europe’s. Hence Greece received several billions in Q2 2010 to meet conditions that they must affectively reduce 10% of its GDP in two years. Of course it will not be achieved without a near civil war. However, at that time markets rallied and the Euro strengthened. We believe that leveraged companies or countries don’t get out of trouble by cutting costs only. They must invest in new initiatives that can generate future income to meet obligations and generate future prosperity. This is an incentive for people to work, and gives confidence to foreign investors so more capital becomes available if projects are developing positively. This is only achieved by receiving fresh capital injections and seeing that capital deployed productively. In the past this was achieved in Greece by devaluing its currency. With the country now using the common currency that is the euro, it cannot apply this strategy anymore.
Selling more means more work in the same unit of time (increased productivity) or simply working more hours. This also reduces quality of life as it generally means working harder and for longer. However, if done well, financial compensation need not be reduced and unemployment rates may not have to increase harshly. However, the question is what do the Greeks sell? Since they primarily deal with agricultural goods and low to medium quality industrial goods, they compete very heavily on price. Since they sell primarily to countries that use the same currency, they must either become more productive or wages must fall to become more competitive and generate higher returns on capital, which can attract fresh capital into the country. As mentioned above, in the past this was achieved by devaluing the currency, a more socially accepted practice to make the country competitive.
When a country is dramatically cutting costs (the public and private sector), all economic participants spend/invest less due to increased uncertainty and unemployment rates, and no new money is coming into the country, there is effectively less wealth in the country as assets prices are declining and the incoming cash flow is being reduced. This means the government is also receiving less tax income, reducing further its creditability and strength. Countries within the EU have also forsaken the ability to print their own currency, a privilege now held only by the ECB. Governments can only ask to borrow more money in the market. When a country reaches the stage Greece is in, this door becomes firmly closed.
As a result the Government of Greece received a bail out package from the European Union countries and the IMF under some very extreme conditions in Q2 of 2010. Furthermore, the Greek banks can only receive funding from the ECB as no other party accepts Greek bonds as collateral for loans.
Because of the extreme cuts required to receive the bailout package, unemployment will rise in Greece. This will encourage less spending, hence the government receives less tax as less business is being conducted. This forces the country to need to borrow more. Hence cutting costs whilst not receiving the benefits from these savings (i.e. used to pay interest payments), or new capital from abroad to invest in the country, will lead to a reduction in GDP. This will lead to more Greeks defaulting on bank loans. This forces the banks to need to raise capital. But the market is not welling to inject new equity into Greek banks at the moment due to the lack of clarity in what will happen. Hence the only funding avenue for Greek banks is the ECB. A lack of confidence in a country is a vicious circle.
So European countries should inject more money into Greece? But the voters in the European countries ask why should they help a country that overspent and did not work hard enough to overcome their problems when they were manageable? Other European countries are also suffering various degrees of discomfort due to a weak economic environment in developing countries in general.
So let the country suffer and pick itself up alone? Why should a single country affect the sustainability of a currency for several economies much larger then Greece’s?
This is a good question. The answer is the financial market in Europe is considerably more advanced in being “Europeanised” then a common European labour market, fiscal policy or language. French banks hold Greek bonds and German banks hold Portuguese debt etc etc. If Greece was to say they could not redeem their debt because they don’t have the cash, then banks around Europe will have to make write downs of several tens of billions of Euros. This would require a number of banks to raise capital, likely creating pressure in European equity markets. Furthermore, Euribor rates would most likely increase as interbank lending costs increase due to a lack of trust amongst banks on who held Greek debt and who would have to make the highest write down and how it could affect their solvency. Europe contains many leveraged economies and increasing the cost of a loan would likely boost default rates if they stayed high for too long.
But again, Greece is such a small economy relative to the EU, the European banking sector could absorb the write downs – only a few aggressive hedge funds would go bust.
However, the real fright comes when you look into the details. The ECB cannot fund the Greek banks if the government defaults on the debt. If Greek business people see their government default on Greek debt: they know the biggest holders are Greek banks and that these financial institutions now have no sources of funding: Greek money will be pouring out of Greek banks into German bank accounts in a last dash attempt to preserve their wealth before their banks collapse. However, governemtns are well trained in such affairs. Capital will be refused to leave the country, as was most recently done in another European country, Iceland. When external capital is not available for banks, deposits are there only source of funding and governments will try to keep them there at whatever cost.
The question is, how will other “weak European economy business people” react if they see that happen in Greece? Will we see large cash movements out from Spanish and Portuguese banks to German banks? Of course we will! Hence, suddenly, there really isn’t a single Europe! Capital cannot move freely around Europe! There is only Germany and a few select others. The market will make that happen. If the politicians don’t throw out the weaker economies by letting one default, the market will probably do that job for them very quickly…
The weak European countries will become like sieves: capital will not be retained in them – what goes in will come out as a result of a total loss of confidence.
Now that is what we envision happen if Greece does not redeem their bonds by taking that decision themselves. There has been discussion of having a voluntary roll over of debt so that a technical default does not occur and hence the Greek banks can continue to receive ECB funding and the Greek government do not need to meet their immediate financial liabilities. But how does this solve their problems? They still have no new capital coming into the country to help rebuild the economy! Hence it is simply being kept afloat! They must create liquidity from the assets they have. This means forced privatizations. But with the economy so weak, these assets would be sold at below normal market condition prices. But this is the price Greece will have to pay. There must be wealth destruction. It can come from a number of ways including defaulting on debt, selling their assets at a cheap price or wages falling (as it cannot come from a devaluing currency anymore). Funds from these savings can be used to reduce their debt load. When this is reduced, new capital from the markets may start coming in.
Wealth destruction is the procedure of removing the money that should have never existed, because it was poorly invested in the recent past. The mis allocation of capital always leads to an eventual reduction of the total capital in the world, as it has not been wisely deployed to increase its size. This would reduce the wealth of the country and hence the quality of life of its inhabitants. How will Europeans react to this? This is a question we do not know how to answer.
But what about the Euro?
If several weaker European countries are made to become “economic sieves”, this would scare foreign investors and likely lead to a sharp reduction in the valuation of the Euro. However, this is only likely to happen in the unlikely event that Greece decides not to pay its debt.
What if the rollover happens, how would the other “weaker countries react?”
“Same as usual.” “Just keep on going and wait for something to change?”
Probably.
An external catalyst seems to be required to start the wealth destruction process. In a capitalist system, this is the most efficient way to allow unsustainable countries, or companies, to start again in less onerous terms.
Another alternative is that the ECB starts printing more money to fund the weaker economies. This is "a la USA", hence would probably lead the Euro to display a pricing behaviour we have seen recently for the USD. However, Germany is very much against this solution and the ECB has so far positioned itself with a similar stance, even if it has bought many billions of government bonds already....
Indeed, one could day that the bailouts are a way of making it easier to have political, fiscal and economic union. Creditors will become the "equity" owners of these countries....
Wednesday 1 June 2011
St Joe Review
Description
St Joe is the largest private landowner in North West Florida, owning over 550,000 acres in this region. The company operates in four segments: Residential Real Estate, Commercial Real Estate, Rural Land Sales, and Forestry.
Current situation
The company has had a lackluster record in making the transition from a paper mill manufacturer to real estate developer. This has attracted the interest of many short sellers who feel the company needs to write down projects they have on their balance sheet. Though we do not disagree with the ideas presented, we feel assets bought many decades ago are more heavily undervalued on the balance sheet then recent projects are overvalued.
The strong reduction in bank lending over the last few years has had a powerful effect on real estate prices, which have fallen strongly in the region where St Joe conduct business. As a result, sales have reduced significantly and profits have been negative for three consecutive years. We note that free cash flow is, however, positive during that period.
The need to maintain properties built and pay employees to (attempt) to sell assets imply the income statement is likely to continue bleeding until the real estate market improves. This situation could continue for a number of years.
However, we believe the large cash load and the strength of the St Joe balance sheet allow the company to survive a very turbulent number of years (net debt is negative).
The survivability of St Joe and the price being paid to purchase their land considering the current price of their stock on the equity market ($21/share) makes it an interesting ASSET PLAY proposition.
Attributes of the investment
A fear of inflation and a weakening USD can lead to more foreigners purchasing US land. St Joe is a pure, debt free, land play in the USA. As a result, in the above mentioned scenario it is likely to attract more attention than it does now. We are also comfortable holding cheap land in a strong inflationary environment relative to cash.
We are also attracted by positive moves with changes in the members of the board of directors (and changes in the executive team) and the consequential focus on reducing non core costs, as well as building relationships with skilled partners in developing new projects on their lands. They seem happier to outsource business that they are not skilled in executing. We are happy by the first developments and the recent candor presented in ST Joe´s Q1 2011 report.
What can go wrong
The company is currently bleeding due to having fixed costs and no sales. This situation can be maintained for some time by the company due to the low debt, high cash position of the company. However, if the company does not invest wisely to ensure buyers/tourists are attracted to the region, land values may not increase strongly or quickly enough before the company is forced to sell more land at undeveloped prices to meet fixed costs paid to ensure the land can be developed wisely.
This investment therefore requires confidence in managements ability to achieve this objective. For the moment we are confident with the changes we are seeing with regards to capital allocation and operating decisions for the company. We follow developments closely.
Catalysts
New management and their initiatives. Improving US economy and real estate markets. New joint venture/ partnerships with skilled and experienced partners to develop new projects on their lands. Increasing traffic at new international airport.
Why is St Joe mispriced (in our opinion)
Large fear in real estate markets at the moment (especially in Florida. We have other investments in this region related to real estate due to the current pricing available). Large short sell position in the stock from recognised hedge fund managers. Poor execution record with regards to sales relative to built capacity.
St Joe is the largest private landowner in North West Florida, owning over 550,000 acres in this region. The company operates in four segments: Residential Real Estate, Commercial Real Estate, Rural Land Sales, and Forestry.
Current situation
The company has had a lackluster record in making the transition from a paper mill manufacturer to real estate developer. This has attracted the interest of many short sellers who feel the company needs to write down projects they have on their balance sheet. Though we do not disagree with the ideas presented, we feel assets bought many decades ago are more heavily undervalued on the balance sheet then recent projects are overvalued.
The strong reduction in bank lending over the last few years has had a powerful effect on real estate prices, which have fallen strongly in the region where St Joe conduct business. As a result, sales have reduced significantly and profits have been negative for three consecutive years. We note that free cash flow is, however, positive during that period.
The need to maintain properties built and pay employees to (attempt) to sell assets imply the income statement is likely to continue bleeding until the real estate market improves. This situation could continue for a number of years.
However, we believe the large cash load and the strength of the St Joe balance sheet allow the company to survive a very turbulent number of years (net debt is negative).
The survivability of St Joe and the price being paid to purchase their land considering the current price of their stock on the equity market ($21/share) makes it an interesting ASSET PLAY proposition.
Attributes of the investment
A fear of inflation and a weakening USD can lead to more foreigners purchasing US land. St Joe is a pure, debt free, land play in the USA. As a result, in the above mentioned scenario it is likely to attract more attention than it does now. We are also comfortable holding cheap land in a strong inflationary environment relative to cash.
We are also attracted by positive moves with changes in the members of the board of directors (and changes in the executive team) and the consequential focus on reducing non core costs, as well as building relationships with skilled partners in developing new projects on their lands. They seem happier to outsource business that they are not skilled in executing. We are happy by the first developments and the recent candor presented in ST Joe´s Q1 2011 report.
What can go wrong
The company is currently bleeding due to having fixed costs and no sales. This situation can be maintained for some time by the company due to the low debt, high cash position of the company. However, if the company does not invest wisely to ensure buyers/tourists are attracted to the region, land values may not increase strongly or quickly enough before the company is forced to sell more land at undeveloped prices to meet fixed costs paid to ensure the land can be developed wisely.
This investment therefore requires confidence in managements ability to achieve this objective. For the moment we are confident with the changes we are seeing with regards to capital allocation and operating decisions for the company. We follow developments closely.
Catalysts
New management and their initiatives. Improving US economy and real estate markets. New joint venture/ partnerships with skilled and experienced partners to develop new projects on their lands. Increasing traffic at new international airport.
Why is St Joe mispriced (in our opinion)
Large fear in real estate markets at the moment (especially in Florida. We have other investments in this region related to real estate due to the current pricing available). Large short sell position in the stock from recognised hedge fund managers. Poor execution record with regards to sales relative to built capacity.
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