Value Investing Ideas

I decided to see how well I’ve done in the last several months. I know how well I’m doing in my real accounts, but what about the stocks I have written about here? As I say, this is for fun, as 8 months worth of data is pretty meaningless for this kind of investing. As you might imagine, if the returns were negative it would be a lot less “fun”. Anyway, here are the numbers:

Not too shabby. It doesn’t really represent my personal investments, as I’ve never owned BXLC, only had BTF very briefly (better opportunities out there), and I don’t remember if I ever held MGA. Furthermore, I’ve been buying ATPG steadily as it fell down into the $3-$5 range. I’ve also been doing some troubled companies investing where the story has not played out yet. There are several other oil stocks I have been buying but not writing about here (PETD, RAME, et al), plus some boring mega cap stocks, and some interesting companies with value to hedge funds.In some way these writeups disappoint me, in that I have several other very good ideas, but on the other hand I feel that what I do write about I support very well, and they have been great performers. Furthermore, they have a lot more legs left.

With all that caveat out of the way, this chart probably still represents some of my best ideas to date.

I’m still very hot on ATPG, ACTS, and IPHS. I have no opinion on the others, as I’m not really following them. BXLC was trading up to $29 earlier in the year, but gave it all up. I wonder if they will ever do something with their cash - it’d still be a home run for investors if they did.

Anyway, compared to the S&P 500, which has an annualized return of about 25% since Dec 15th, I’d say I’m doing satisfactory.

I wrote about Actions Semiconductor here. The story has changed somewhat since then, but in a good way. Better yet, although the stock price has recovered somewhat, this is still a net-net play, and it is still trading below cash on book.

At the time I wrote the original writeup ACTS was resisting buying back shares, preferring to “grow” the business through acquisitions. Indeed, they ended up making a bid on an manufacturer, and it looked like a done deal. Management was playing this close to their chests, refusing to discuss the business or its prospects in their conference call. The analysts were very persistant, and several emphasized the extraordinary value that could be created by buying back ACTS ADRs.

Well, management listened. The acquistion was cancelled, and ACTS has retired over 9 million shares, or just over 9% of the outstanding stock, leaving 86MM shares outstanding.

At this point ACTS has $236.5MM of cash and equivelents on their books vs a market cap of 200MM. So, on cash alone you are still buying $1 for $0.85.

How about the business? Well, in this extremely difficult global crisis, they lost $0.02 two quarters ago, and $0.01 this most recent quarter. In other words, during global financial catastrophe they almost broke even, and had a huge war chest that would have protected them had they lost real money.

How about costs? Well, at the beginning of the year they announced that they were cuttting the salary of senior management by 20%, and then they cut the manager level salaries by 20% in the second quarter. They have not reduced the salaries of the technical staff. Management is eating their own cooking.

As I wrote before, this is a tough business sector to value. Changing consumer tastes in gadgets makes it extremely difficult to build a moat unless you have significant IP (have I written about DMRC? - they have a moat). Still, trading at a discount to cash, a huge war chest, and pretty much breaking even during a major worldwide crisis - it’s a no brainer to me. This company is ripe for a takeover, or merely for the share prices to recover once earning return to a normal level. In either case, management is continuing to help make your investment more valuable by buying back and retiring shares.

Several of you have asked me for updates on ATP. Rather than blather on, I’m mostly just going to link to an excellent write up on an analysts breakfast held by ATP this Thursday, where the bull case is laid out far better than I can make it.

However, let’s look at developments since the last time I wrote. ATP is pressing full steam ahead in developing Telemark, their company changing lease in the GOM. When it comes on line it will more than double ATP’s production. They got the developers to agree to foot the bill for the development, about $200MM, in return for getting paid with future profits. They have several asset monetizations in the works - selling the Gomez pipeline, selling Titan, et al. Al Reese said this is as “close to 100%” sure as anything could be, as you will see in the link. GE and other companies are interested.

As is typical with these fields, the reserve volumes used to calculate PV-10 is very conservative. If you look back at ATP’s history, they’ve beat these estimates by huge margins. Don’t get tooooo excited about that, as that extra production comes in on the back end, and the present value of money means you have to discount those cashflows over several years. But still, take the > $5B in reserves as a low ball estimate.

They have other irons in the fire. North sea, for example. They are currently bidding on and winning new leases in the GOM near their current hubs.

Their bankers are working very closely with them over Telemark. They recognize the great value in that field, and it’s pretty hard to believe they’d shut down the company to get their money a few weeks earlier. The risk right now is that ATP is not going to do their monetization for the debt until Titan is in place and ready to go, so if there were significant delays they could actually blow a few covenants.

I said Telemark is company changing. Let’s put that in perspective. At todays strip prices, ATP’s cash flows next year will equal the current market cap. Yes, ATP is trading at 1x 2010 cash flows. A typical number is more like 10x. ATP plans to have *all* of the debt paid off by then.

Okay, so I did blather on. Anyway, here is the link backing up those points.

http://boards.fool.com/Message.asp?mid=27920815&sort=postdate

There have been quite a few positive developments in ATP since I wrote about them last. Perhaps I will address them in a later post. However, elsewhere you see a lot of hand wringing over whether ATP will execute their plans for the next few quarters. Make no mistake, if they do execute them (and I see no reason why they won’t) it will be a transforming event for them - huge free cash flows, all debt paid off, etc.

However, for any company I own I try to “break it”. Figure out what can go wrong in a perfect storm, and get a feel for the results.

The PV-10 value of ATP’s reserves is $5.3B. The infrastructure value, almost all of it new construction with a 25-40 year life span, is $1B. That value is based on what it cost ATP to build it, not the present value of cash flows they will generate (which of course will have a greater value). This number is backed up by the deal made with GE, where GE paid the estimated value for the Innovator platform.

Total liabilities, including long term debt, income tax, accounts payable, etc., is just under $2B. That gives us an enterprise value of $4B, vs a current market cap of under $500MM. A pretty huge disconnect.

Why is the stock price so low? Everyone is hand wringing over the debt covenants. When ATP renegotiated their debt, it came along with a bunch of provisions, most of which I talked about before. They had to sell assets, devote 75% of the proceeds to debt reduction, they had to earn revenues at some multiple of the debt, etc.

Of their covenants, the requirement that debt be less than 3x EBIDAX gets the most attention. Right now the plan is to make the majority of that money via asset sales. They were helped along with a sweetheart deal with a driller, whereby the driller pays for the cost of development and gets paid with profits. Still, ATP has to execute some sales to meet the covenant.

But, is this a big deal? Sure, we don’t want them to blow the covenant. But suppose they do? They won’t go bankrupt over it, but pretend they did. ATP would be put up on the block, and over $6B of assets would be sold to generate $2 worth of money to pay off debtors.

While we would all be extremely disappointed by the demise of a company with such a great future, under any reasonable scenerio there would be more than enough money to pay off shareholders. Would we end up with $70/share? Probably not, trying to sell that many assets at once in this environment probably means we’d end up selling some things for less than they are worth.

So, while I’d hate for them to end up bankrupt (let’s very clear here, I don’t consider that a real risk), it’d hardly be a disaster. I’d fully expect to make money from the deal.

Realistically, blowing a debt covenant means sitting down with your debtor and renegoiating terms. Sure, they could demand repayment in full immediately, forcing some kind of bankrupcy proceedings. But is that likely? Given that ATP recently coveyed 3 limited-term NPIs for the development of Telemark (meaning the devlopers pay for the development, and get paid from future profits) we can conclude that there is future value in ATP. Debtors are unlikely to walk away from such cash flows. Instead, they’ll turn the screws a bit and get more favorable terms. Nothing is guaranteed - a debtor that needs cash can always demand repayment, but it is unlikely. If it does happen, stockholder still win, though much less than they could have.

So, what is the fear that makes ATP trade so low? I don’t know, I’ve never seen anything reasonable articulated.

edit: I haven’t bothered looking at all the little terms in the debt - with that we could get a more realistic assessment of what happens if a debt covenant fails. My position is: who cares? If I win even if the company breaks I don’t need to know much more.

This has always struck me as an easy question, so the amount of handwringing over it has always left me nonplused. To be fair, many of the top value investors, people I admire, have said it is a tough question, so perhaps everything I write in this post will be wrong. But, judge for youself.

It’s my impression that people use the wrong mindset when deciding to sell. They seem to drop their value investing roots and start to try to guess what the market is going to do in the short term. If you try to do that, then yes, it’s hard to decide when to sell. It’s my opinion, backed by a lot of evidence, that no one can determine short term market movements. If so, if you try to do it all you are doing is speculating. It’s no more correct to speculate on the sell side than on the buy side.

Okay, so how do you decide to sell? Well, the most important thing to understand is that money has no memory. For example, say you buy a stock, some bad news comes out, and it drops 20%. Let’s say it is really bad news - a fundamental shift in the outlook for the company. In this case it makes no sense to just hang on, hoping to eventually make up the 20%. You sell, take the loss, and put the money into a better company.  Your $800 doesn’t know it used to be $1000, and that company is not going to increase in value just because you invested in it and took a paper loss. Always, always, always put your money in an investment with the best rate of return.

So, we use that simple rule to decide when to sell. The rest of this argument is going to be phrased as if you are buying another stock, however, the argument still works if you are going to take the money and put it in a sock drawer or buy a boat with it. Why? Because money has no memory. It doesn’t know if it was used to buy a new stock, or a new boat, or whatever.

Okay, since money has no memory, don’t bother looking at your account and saying “I have 10,000 shares of XYZ”. You do have them, but that knowledge doesn’t affect the sell decision. You certainly don’t say “I bought 10,000 shares of XYZ at $10.00″. That also doesn’t affect the sell decision.

Pretend you have $100,000 to invest. In the entire universe of stocks, what stock or stocks would you buy? The very best stock you know of.

How you make that decision depends on your version of investing, and I won’t go into that here. But obviously you will be looking at FCF, multiple vs yield, your expectations of the future, and risk/reward.

Let’s say ABC is selling at $5 and you think it is worth $10. XYZ is selling at $10 and you think it is worth $13. Both have equal risks and uncertainty. In this case, forgetting for the moment that you own XYZ, you’d definitely buy ABC. Well, how do you get that 100K to invest in ABC. Well look! You have $100K worth of XYZ in your account. Sell it and buy ABC.

That’s extremely straightforward. Just own whatever you think are the best bargains out there. If that means you have to sell something, so be it. Every time you sit down to review your portfolio, figure out what you want it to look like, forgetting what you own now and the paper profit/loss on those. Then, do whatever you need to do (buy/sell) to make your portfolio look like it should.

A few complications: The US government taxes you differently based on your holding period. 15% vs 30% or whatever your effective tax rate is. There are dividends, currently taxed at 15% unless you have an MLP or somesuch. Etc. Natually, you have to factor those into the equation, but they are pretty simple. In this case you could argue the problem gets a lot harder, because you are deciding between selling today at a known price vs next year at an unknown price. Here I pretty much assume no changes in prices, which is a bit conservative given that over time markets rise. You could look at beta, but I think that’s a bit of voodoo.

Another issue related to taxes. Say you bought XYZ, and it dropped 20%. You love this stock, and the price drop was irrational. Normally you’d back up the truck, right? Well, let’s say ABC is equally depressed, and you love ABC just as much as XYZ. In this case, sell XYZ, take the tax write off, and buy ABC. You have the same dollar amount in stock as before, the future is equally bright in ABC vs XYZ, but now you have a juicy tax write off!

The final thing I might think about is delaying the tax bill. If I am figuring out what to sell and it is Nov 30th, I may just wait until the next fiscal year to sell my stock, merely to push the tax burden out a year. But this only works if you aren’t filing quarterly. If you are managing serious money, you are probably filing quarterly.

This post implies a lot of selling/buying. I hope that isn’t the takeaway point. If you bought Berkshire in the 80s and love it, why sell for a few extra percentage points? You know Buffett, presumably you agree with his investment and business philosophies, why go to somebody untried? But that should be part of the decision of “what do I want my portfolio to look like”? Me, I want some solid, indisputable performers like Berkshire, and then some higher risk, but world changing returns like ATP. That way if my risky buys don’t work out, I still have a comfortable nest egg. If they do work out, I’m not just comfortable, I’m very well off. But, here we are veering into buy decisions, which is a different topic.

So, my advice is pretty simple. Figure out the optimal portfolio for you, and just make it happen, not worrying about what you currently have in your portfolio. But don’t give Uncle Sam too much extra money if you can avoid it.

Disclosure: I own ATP, I don’t own Berkshire. They were just chosen as examples of different risk/reward profiles.