The UnRIGged Transocean: On Watch (as a Long)

I considered going long Transocean (“RIG”) in fall 2011, and did so (briefly) for a trade. It would not have been a bad investment had I stayed on. I am re-visiting RIG as a long through the end of the year, and may initiate a long (and update this post) at any time. Per @mmtul:

RIG the pig, below ’08 lows. Well done! For the past 20 years, P/B range = 0.7 to 4.1. Currently 0.77. What do you think, Carl [Icahn]?

I initiated a long earlier today, and (accidentally via ‘fat finger’) put on a position 10x larger than I had intended. I closed it (fortunately, not at a loss) to re-evaluate. I may start building a long position tomorrow.

A few things that interest me and are worthy of further examination:

  • Short interest is high – 12 days to cover, over 20% of float is short. Short interest is nearly 10x higher than 12 months ago.
  • Day rate trends, price of oil.
  • Russia
  • Secular/structural considerations

The Madoff Ponzi Scheme: For every $1 “invested” how much have investors recovered? More Than MF Global Shareholders

In this day and age, the name ‘Madoff’ is synonymous with ‘financial fraud’, ‘ponzi scheme’, etc. Yet how much harm has Madoff done, in $ terms and % terms? While Madoff’s wrong-doings are indisputable, the damage all too real for its victims, the answer may surprise you…

As of July 23, 2014, the Securities Investor Protection Act (SIPA) Trustee has recovered or entered into agreements to recover approximately $9.825 billion, representing approximately 56 percent of the estimated $17.5 billion in principal lost in the Ponzi scheme by Bernard L. Madoff Investment Securities LLC (BLMIS) customers who filed claims. This recovery far exceeds any prior restitution effort related to Ponzi schemes both in terms of dollar value and percentage of stolen funds recovered.

source: http://www.madofftrustee.com/recoveries-04.html

Madoff’s victims have recovered 56% of their principal, whereas Corzine/MF Global’s victims – I mean, shareholders – is ZERO. To be fair, Madoff’s scheme and lies were longer lasting, and probably much more deliberate/malicious. Yet economically, who has harmed investors more? I will that to those far wiser to answer, but I believe it is a fair question.

In Anticipation of the Next “AOL-Time Warner”

This post was inspired by a @PlanMaestro who wrote: “Prediction: #PullingAnAOL will start trending soon.” I fully agree.

As “everyone” knows:

  • Interest rates remain low (and in many cases, negative)
  • Corporate cash balances remain high (at least in the United States, part of the reason there are inversion/tax related “controversies”)

As some know:

  • Capital/wealth has really nowhere to go other than the private sector, as public sector returns are de minimis. Corporate bonds/equities, hard assets, venture capital and private equity are the only game in town. I believe US is (largely) the only game in town as well.
  • Confidence in the corporate sector (C-level suites) is increasing.
  • Mergers and acquisitions are “back”
  • US Equity valuations are on the higher end historically, but can arguably go much higher given the prevailing low interest rate environment AND due to the pressure capital has to flee public sector and go SOMEWHERE.
  • The relatively high equity valuations have some interesting effects: (1) C-level executives face greater pressure to justify their existence, and so will look for ways to prop/grow EPS. (2) high valuations mean cheap currency, so acquisitions may seem, and may occasionally even be “accretive” (3) High valuations may lead otherwise mediocre/poor managers into thinking they are actually competent, and deserving of their absurdly high compensation packages. This dangerous and misplaced rise in confidence may encourage people to take on risks via M&A they otherwise would not.

All the above conditions lead me to believe we are in ripe territory (said differently, in dangerous territory) for a few eventual AOL-Time Warner debacles… I mean, deals. I’m giving it 5-6 quarters. Personally speaking, I am less interested in identifying potential targets on the long side… I’m not “smart” enough to do that. I’ll leave that to other Long/Short and Event-driven folks (I may change my mind, as I somehow magically transform into a super talented long focused guy with the power to foresee acquisitions). I am much more interested in getting involved ex-post. This leaves me plenty of time to observe the frauds and follies that I believe will come to fruition in the near future. 

 

About AOL-Time Warner

“Every time it [AOL] got to a clean quarter, it would buy something so you never saw internal growth. Total scum.” – Lisa Thompson from http://twitter.com/LTommy256/status/508807681579425792

It is my understanding that the AOL Time Warner deal gloriously harmed quite a few short sellers. Kynikos Associates, Rocker Partners, etc. I believe the list of those who lost money shorting in that situation is a “who’s who” list. I believe losses on shorting AOL were in the order of 10x. Note that time actually vindicated the AOL shorts… but little comfort in being “right” and losing considerable amount of capital.

 

David Rocker, Rocker Partners on AOL:

“Ask what the bull case is, other than bull generally,” demands David Rocker, a New York hedge fund head who says AOL is still one of the market’s most overvalued stocks. 1996

source: http://articles.baltimoresun.com/1996-07-28/business/1996210078_1_aol-america-online-steve-case

In addition, the company used questionable accounting practices for new  subscribers and marketing revenue to improve its short-term financials. These practices  would lead to a $385 million write-off in 1996, and accusations that the company was
“morally bankrupt.” 

Former CEO Kimsey described the accounting issue
as “the big turd” that “sat in the middle of the company and smelled up the place.” Id. at 57. Short-seller Rocker
claimed that for AOL, “every revenue is ordinary, and every expense is extraordinary.

http://blogs.law.uiowa.edu/jcl/wp-content/uploads/2012/01/1-Bodie-FINAL.pdf

A well-known short seller of America Online, meaning he has bet that its stock price will decline, Mr. Rocker said that the company inflated its quarterly results by spreading its high marketing costs over two years. At the same time, it was reporting costs to the Government, reporting a loss to receive tax breaks.

”They have been telling the Government the truth, but they tell investors something else,” he said.

source: http://www.nytimes.com/1996/10/30/business/america-online-announces-a-newer-transformation.html

 

Jim Chanos, Kynikos Associates on AOL:

Q: what was your biggest mistake?
A (Jim Chanos): AOL. It was a short due to accounting, we thought they were masking higher churn then they reported. We thought the value of a subscriber would turn out less than they thought. We started shorting at $2-$4, covered as it went up, and covered the last at $80. We kept it to a 1%-1.5% position. We knew we were in the midst of a bubble, so we kept it small, but it still cost us 10% over 2 years.

source: http://myinvestingnotebook.blogspot.com/2010/05/jim-chanos-power-of-negative-thinking.html

 

What if the SEC were to Launch a Largecap Fraud Task Force: the Ode to the SEC Edition

The Securities and Exchange Commission (“SEC”) recently launched a Microcap Fraud Task Force. It appears that the SEC’s efforts are already bearing fruit:

Washington D.C., Aug. 5, 2014

The Securities and Exchange Commission today charged four promoters with ties to the Pacific Northwest for manipulating the securities of several microcap companies, including marijuana-related stocks that the agency has warned investors about in recent weeks.

The SEC alleges that the four promoters bought inexpensive shares of thinly traded penny stock companies on the open market and conducted pre-arranged, manipulative matched orders and wash trades to create the illusion of an active market in these stocks.  They then sold their shares in coordination with aggressive promotional campaigns that urged investors to buy the stocks because the prices were on the verge of rising substantially.  However, these companies had little to no business operations at the time. The promoters reaped more than $2.5 million in illegal profits through their schemes.

Two of the companies manipulated in this case – GrowLife Inc. and Hemp Inc. – claim to be related to the medical marijuana industry.  The SEC has issued an investor alert warning about possible scams involving marijuana-related investments, noting that fraudsters often exploit the latest growth industries to lure investors into stock manipulation schemes.  Other schemes by these four promoters involved an oil-and-gas company – Riverdale Oil and Gas Corporation – and three other microcap stocks, ISM International, Allied Products Corp, and Aden Solutions.

The SEC was able to unearth the schemes through the work of its recently created Microcap Fraud Task Force.

“Our Microcap Fraud Task Force is taking direct aim at abusive practices and serial violators within the microcap markets like these four promoters seeking to exploit retail investors for personal gain,” said Michael Paley, co-chair of the SEC’s Microcap Fraud Task Force.  “In this case, we meticulously reviewed trading records and developed the evidence necessary to connect these four promoters and their coordinated trading efforts.”

Source: http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370542594818#.U-GbJvldVz7

Here are a few thoughts that come to my mind:

  • The SEC has done an excellent job recently in addressing microcap related fraud. The SEC (nor any government or private operator) cannot eliminate bad behavior, nor is it to blame for others’ wrong-doing. It can, however, react swiftly, justly, and thoughtfully in the instances of alleged wrong-doing.  The SEC is very clearly part of the solution, not the problem. It is evident to me that they have responded very effectively in many of these recent microcap fraud cases. The SEC was remarkably quick to respond to the CYNK fraud recently, contrary to claims otherwise. The SEC is very clearly part of the solution, not the problem. The SEC deserves praise and the full support of all those willing to speak up against bad behavior in the markets.
  • It remains a shame that it is far easier to earn $2 million by manipulating and promoting stock frauds, rather than exposing them. That being said, we Americans are blessed that the SEC targets the stock fraud promoters, rather than the short sellers who seek to expose them. It seems clear that the SEC is aware that for every 1 short seller who may break the law, there are likely 100s-10,000s+ longs and corporate issuers/managements who break the law via stock manipulation, fraud, etc. Nearly all the illegal profits/injust enrichment are reaped by the longs/corporate issuers.
  • If the SEC were to create a thoughtful and nimble Largecap Fraud Task Force (coinciding with similar efforts on the part of the Justice Department and certain state Attorney Generals)… one can only dream. The societal and market-places benefits would be immeasurable. I estimate the societal and market-place benefits would last for at least a generation. More on this (possibly) later.

 

“My business is to comfort the afflicted and afflict the comfortable” – Mother Mary Jones

The Greatest Victory is the one with Least Bloodshed: The Microsoft/Valueact Edition

Even former Microsoft CEO Steve Ballmer noticed a change at his company when ValueAct showed up last April, saying shares were undervalued in part because investors were overlooking Microsoft’s continued success selling many of its software products to corporations. The longtime executive credited ValueAct for helping to change investor sentiment toward Microsoft.

“Maybe starting with the ValueAct investment…there was a wave of, ‘Oh yeah those guys have a phenomenal enterprise business,’” Mr. Ballmer said in a May interview.

The other sea change at Microsoft around ValueAct’s investment was Mr. Ballmer’s surprise retirement, announced a week before ValueAct got on the board. Mr. Ballmer and other Microsoft officials said pressure from ValueAct played no role in his departure.

Source: http://blogs.wsj.com/moneybeat/2014/06/20/success-of-valueact-hedge-fund-has-dented-its-maneuverability/

 

As measured by market cap impact, it seems Valueact’s Microsoft activism has been the most effective. And they achieved it with minimal heads rolling, minimal/zero glitz/glamour, and minimal/zero Jersey Shore media campaigns. In short, the greatest activist victory (in recent memory), was achieved with the least bloodshed (and fanfare).

I believe it’s safe to say Valueact wants to remain low key, maintain a low profile (except to the extent that further attention will cultivate and bring about culture change in the investment world, specifically but not limited to, shareholder activism).

That being said, it would seem that it will be very difficult (for now) to maintain a low profile:

But its maneuverability appears to have been dented. For most of its history, stock prices of companies it took activist stakes in generally ticked down in the year after the firm disclosed its positions, letting it scoop up more shares for a discount  said ValueAct President and Microsoft board member Mason Morfit. In the last year, the stock prices of its picks have “popped” as other investors mimic ValueAct’s moves. All the attention is “to our chagrin,” Mr. Morfit added.

Here are some ideas:

  • Talk to management teams under assumed names (rather than Valueact’s)
  • Add some serious capital allocation to short selling (probably need to hire someone to lead the charge). This way, it’ll be easier to confuse market participants

 

 

Goldman Sachs, Illegal Market Manipulation, and Short Squeezes

In 2011, the U.S. Senate Permanent Subcommittee on Investigations said Salem and other Goldman Sachs traders tried to manipulate prices of derivatives linked to subprime home loans in 2007 for their own benefit. The subcommittee’s assertions were based in part on Salem’s self-evaluation, in which he wrote “we began to encourage the squeeze with plans of getting very short again after the short squeeze caused capitulation of these shorts.”
Goldman Sachs denied any attempted manipulation.
“The translation of that sentence is, you know — is very different than it was, at times, made out to be,” Salem said at the hearing. “There’s no wrongdoing in that sentence.”

 

from: http://mobile.bloomberg.com/news/2014-06-18/ex-goldman-trader-says-bonus-cut-to-8-25-million-unfair.html

Idea Generation: Revisiting Broken Investment Theses (In Celebration of 13Fs)

In 2013, long Yahoo! (“YHOO”) was a big winner for some in the activist/event-oriented world (e.g. Third Point). Yet the long Yahoo! thesis had been around … for quite some time (remember Icahn circa 7 or so years ago?). Recall Greenlight articulated largely the same long Yahoo thesis in 2011…and capitulated in 2011. Long Yahoo! was a broken thesis that transformed into a beautiful thesis.

Microsoft was a perma value play, coming up as a popular long idea in value-oriented conferences, and value circles… but it was ValueAct in 2013 that really got it right.

So perhaps the far more elegant way to use 13Fs are not to follow what other investors have done… but to look for ideas that they give up on, and bet the other way (or examine the merits of doing so). 

Remember Meredith Whitney? Remember all the negative sentiment (rightly so or otherwise) towards her in the last few years, specifically with respect to her munifinance/bond prognostications?

For some reason, this recent @MuniLass* kerfuffle got me thinking that perhaps Whitney’s broken thesis is worth re-examining. From a narrative perspective, it just makes sense –  I’m going to give it 24-36 month to come to fruition, in some form.

 

* Blessed are those who protect the anonymous. I find her outing troubling… that being said, I once followed her briefly years ago, but unfollowed her because I found her unnecessarily nasty towards others. The disrespect and vitriol I sensed in her words (towards those who have variant views) were notable. Short seller regularly receive far worse than I ever saw her receive, but nearly all short sellers simply ignore the threats, false accusations, etc.

::UPDATED on May 16, 2014 8:45 AM EST::

Perhaps a 50% haircut on WWE is reason enough to revisit its long thesis…

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