Sunday, June 19, 2011

Howard Marks Is Selling: Should You Be Buying?

Surely it was all coincidental: Howard Marks, probably a top three favorite manager of mine, recently released a book ("The Most Important Thing: Uncommon Sense for the Thoughtful Investor"). A chapter from the book was the front page story in last month's Institutional Investor magazine. In March there was a lengthy Fortune/CNNMoney feature on him. Then on Friday 6/17/11, Bloomberg Markets ran a long profile with details all the way to his diet and parental occupation, casually mentioning that Oaktree is... going public. The Bberg article was time-stamped at 17:43, while the S-1 filing was stamped at 16:25. A marketing professional might call this "generating buzz around the brand": turns out, the sudden burst of publicity had a reason.

Mr. Marks is a true legend: according to the S-1, his distressed debt funds have averaged a gross IRR of almost 24% since 1986 with Sharpes above the benchmarks. This is nothing short of phenomenal: remember that we are talking about credit here! Very few equity equity managers can claim a record like his, let alone managers in the fixed income space. Interestingly, Oaktree was an early investor in Jeffery Gundlach's DoubleLine, a new but already stellar fixed income fund family, despite Mr. Gundlach's "difficult" separation from TCW.

Unlike many other investors, Mr. Marks has been very generous with his insights. His "Memos From Our Chairman" are available on Oaktree's site, and I strongly recommend that people read them all. There was also a 700-page pdf collection floating around with many of the letters combined: between Mr.Marks and his colleagues, we are talking about hundreds of years of investing experience all distilled for you. He really drives a few points: the primary job is to control risk. An investment cannot be viewed as more risky or less risky without discussing the price: at the right low price, nothing is too risky. Mr. Marks is known for returning capital to investors when the opportunities are not there, and for putting money to work when the window is open ($6 bn late 2008, just like Warren Buffett, except that you never read about Howard Marks riding on a white horse in the GS boardroom and asking for usurious preferred stock). There are a few other insights in the letters that you should discover on your own, including a few from an "earlier" version of Michael Milken.

So here is a guy who was buying during the biggest liquidation in a generation, and now he is selling a piece of his management business (not in the funds themselves): should you be buying? In a word, no. Here's why:

(1) Just common sense: don't be seduced by explanations such as "liquidity needs", "permanent capital", "estate planning" and the like. Another professional seller partnership, called Goldman Sachs, went public in 1999: you all know what happened to the market soon after.

(2) Are we at the end of the bull market for credit? The economics of the fund management business are driven by the fund results and the AUM. The two are inter-connected: good results beget higher AUMs. We have had a 30-year bull market in credit, and the phenomenal results we have seen might not be repeated by anyone at any time when the credit cycle reverses upwards. If you look at the 10-year yield chart since 1980, you are seeing a series of lower highs and lower lows. This means that a high yield loan might be at 10% initially, 25% in distress (when Oaktree buys it), and then at 8% when things stabilize ("lower low"). The IRRs would not be there if the credit cycle were going the other way, i.e. 10% new/25% distress/15% stabilized.

(3) Unfavorable structuring for the investors: the units do not have voting control, lose some of the tax benefits, generate peculiar income tax liabilites, and a few other things that make them differ substanitally from a "normal" stock

(4) Generally poor performance by investment manager LP units in the market. Oaktree is not the first partnership to go public. AllianceBernstein has been public for a number of years. In more recent history, Blackstone, Ochs-Ziff and Fortress all marked the top with IPOs in 2007, and proceeded to tank 85-95% off the IPO price (!) in 2008, and they are still at 50-85% off. AB, too, was $92+ in 2007, and is at $19 now. In recent months, we've had the IPOs of PE titans KKR and Apollo, and a recent bake-off by The Carlyle Group: again, remember that these are professional sellers. This, and the record of unit performance post IPOs, make me unenthusiastic about the offering. That said, to channel my inner Howard Marks, if the price is low enough...

Friday, June 17, 2011

M&A Activity This Week Indicative of Peak Cycle

Back at the end of April of this year I wrote an article asking where are we in the current economic cycle. I looked at several "real time" indicators such as profitability of cyclical companies and the IPO pipeline, and I thought that there is evidence suggesting that we are at the "peak". The stock market has certainly been unhealthy since then with several recent IPOs burning their investors, and the collapse in commodity and China stocks.

We also had a lull in merger announcements recently (one of the other factors I had looked at), until this week. While by no means a predictive factor, I like keeping an eye on what is happening in the space as it captures several factors at once: management's views of the future, management's view of the value of cash vs. own stock, equity and debt financing conditions, industry consolidation drives, even mood.

So here are a few noteworthy deals, events related to deals or rumors that happened just this past week. While the S&P500 might have been down 6-7 weeks in a row, it does not seem that the M&A cycle has slowed.

-CapitalOne possibly acquiring ING Direct for $9 bn: this is one of the largest deals this year and will make CapitalOne big enough to be TBTF (7th largest by assets) and enjoy the unfair funding advantage that comes with it
-Energy Transfer buying Southern Union for $4bn+/~$8 bn EV: this is a gas pipeline consolidation, everyone knows the US natural gas story
-Allied World/Transatlatic $3bn+ reinsurance deal: I don't have the details/views on this one
-Avis car rental buys back into Europe for $1 bn: high-beta company expansions are peak cycle material
-Graham Packaging going with Reynolds/Rank instead of Silgan: this is after another unsolicited deal on the paper side, with International Paper going after Temple Inland
-BJ's Wholesale Club being acquired by Leonard Green Partners and CVC. BJs had been on the block for a while, and LGP is a PE firm well known for its expertise in retail.
-Wendy's selling Arby's for a paltry sum upfront: while it does not look good on WEN, the fact that there was a buyer (Roark, big investor in restaurants) is a positive sign
-Unusually high profile hostile deal with the Toronto Stock Exchange means that people are braver
-Boyd Gaming making a small Gulf resort purchase: this is a regional destination resort, would be interesting to see the traffic numbers trends there vs. slow/no-recovery markets like LV or AC
-HCA is buying out JV partner in 7 Denver hospitals for $1.45bn: while most financial media attention has been focused on the big pharma decline, it is interesting to see what hospital operators are doing in light of the greatest industry uncertainty in many years
-Dish Network offers $1.4 bn for TerreStar out of Chapter 11
-Air Products buys a semiconductor industry suppliers: this is peak cycle material

-The two Russian fertilizer behemoths Uralkali and Belaruskali are denying talks: when there is smoke and industry consolidation, there's fire
-Blackstone in exclusive talks with Jack Wolfskin: interest in discretionary brands is usually a topping signal (also of note, the Samsonite and Prada IPOs in Hong Kong were not blockbusters)
-GM might be selling Opel again, this time from a position of relative strength
-Glencore denies interest in a large Kazakhstan commodity company

What is the conclusion? We are seeing more of the typical signs of peak-cycle merger activity. There are deals across many sectors. Some of the deals are very substantially sized. Some of the deals are hostile. What we are not seeing is high equity vs. cash usage: part of this might be that there is a lot of cash sitting around earning nothing. While not indicative of where the market will be next week or month, we are seeing that the corporate titans are still optimistic and willing to take on high-risk moves.

Monday, June 6, 2011

An Accidental Victory Against Credentialism: When A Nobel Prize Isn't Enough

President Obama's Federal Reserve Board nominee, Mr. Peter Diamond, just joined tens of thousands of recent college graduates who discovered that having their degrees and awards is insufficient in getting hired. Unlike Mr. Diamond, however, the generation saddled by student loans and tasked by Obama himself with "Winning The Future" do not have the option of going back to their "congenial professional existence as a professor at MIT."

Mr. Diamond penned a widely-read op-ed in the New York Times on June 5th, 2011 ("When a Nobel Prize Isn't Enough"), in which he laments his inability to get hired despite his expertise in the labor market. It is fairly ironic that a labor market "expert" cannot get himself hired but this speaks to the wider disconnect between high-rent academics (as well portrayed in the Oscar documentary "Inside Job") and the real world.

Here's the news, Mr. Diamond: what you offered to the people who have to approve your nomination does not meet the market needs. You may view this as unfair, as an affront to your lifetime achievements, as idiotic, as politically-motivated, and so on, and, no doubt, these are all true statements, but may be you should just accept that the trebuchet of reality has demolished your self-congratulatory ivory tower. The process has been political circus of the lowest order but don't hate the player (Senator Shelby), hate the game. And stop with the sense of entitlement: clearly your Nobel is not enough for the market. Markets are forward-looking and the market has clearly communicated that it would like to see people who do not rubberstamp every decision, as has been the case all along.

I have been on both sides of the "credentialism" wars and I am an active proponent in demolishing academic and professional "branding" through initiatives such as Khan Academy and the Thiel Fellowships. An Eight Schools Association boarding school, followed by a legacy admission to an Ivy League and a fencing championship, followed Goldman prop desk easily leads to hundreds of millions for a "start-up" fund: but what percentage of this success is linked to parental zipcode and the access/socialization associated with it, rather than merit?

Thursday, June 2, 2011

Too Long for Twitter, Too Short for Separate Posts

 I am crossposting here and on Davian, the technology and marketing partner for my inflation-oriented autotraded product.

Spain, just like China, has its own set of empty towns. Whenever you see these satellite pictures, you can be sure that there is a bank somewhere holding the bag (or keys, if you'd prefer). Long periods of mispriced credit look great on the income statements but, as they say, the balance sheet is the future.
Currency devaluation chart from the Roman Empire: tracking the decrease in silver content in the coins over the years. Persistent currency devaluations seem to cause a lot more problems than they solve. Since it is difficult to imagine life without money, I wonder if there are two future scenarios possible: a "stable" global currency (many countries do not have own currencies now as it is) and/or a group of competing or complementary private currencies without governmental control. Private currencies would need major network effects to be successful, so, dare I say it, hello facebook dollar!
Speaking of countries that need a new currency, look at Belarus. After its currency devaluation, the government decided to freeze food prices until July 1st of this year. These attempts never really work and lead to shortages. Other Eastern European countries learned the hard way and have been operating with currency boards for many years quite successfully as a stable currency is major factor in predictability, and, hence, economic development. In general, countries that are not that great at self-governance are not that great in managing their currencies, either, and the populace knows this so most contracts are denominated in the "USD equivalent of..."
Energy is a precious resource that should be used judiciously. I wonder if some emerging markets are making a major mistake by encouraging the rapid automobilization of their countries. The single-driver daily commute is very energy intensive, often stressful, and a noticeable waste of time for highly specialized labor. No easy solutions exist for the US but some markets might be making the mistake of copying the US model.
The ore barons in Australia and Canadian homeowners might not have a full idea what is coming to them if/when there is a slow-down (or worse) in China.
Three quotes I posted on Twitter recently that got "mileage":
Coco Chanel: "Some people think luxury is the opposite of poverty. It is not. It is the opposite of vulgarity."
Leon Trotsky: "You may not be interested in war, but war is interested in you"
George Orwell: "If liberty means anything at all, it means the right to tell people what they do not want to hear."
On the topic of liberties, the gradual erosion of liberty is in full bloom. Recent court decisions have rolled back rights going back to the Magna Carta (that's 1215 AD), including the right to due process. We're not at the EU stage of targeting free speech as thoughtcrime but we are getting there (“one sees the sun slowly set, yet one is surprised when it suddenly becomes dark.”)