Month: April 2007

Cemex Cements The Deal

Cemex Cements The Deal

Posted on by David Merkel

Cemex finally achieves it great ambition of becoming the world’s largest cement company by market capitalization with its acquisition of Rinker. Holcim and Lafarge slip behind Cemex.

Cemex is still cheap in my opinion, and will wrench cost savings out of Rinker. The US authorities have already passed on the deal, telling Cemex what they must divest. The market rendered its own verdict, sending both Rinker and Cemex up in price. That’s a good sign for the future.

Today was another good day for me, with Cemex leading the pace, followed by Bronco Driling and Anadarko. Trailing the pack were Dow Chemical, Tsakos Energy Navigation, and Komag.

Full disclosure: CX LR BRNC APC DOW TNP KOMG

Dow is Up; the Dow is Flat

Dow is Up; the Dow is Flat

Posted on by David Merkel

The broad market portfolio did well yesterday. A leading reason for that was the rumors regarding Dow Chemical being acquired by private equity. I don’t care about private equity, Dow Chemical is cheap; I’ll own it anyway. Also adding to the party was YRC Worldwide. In an economy as strong as this one, trucking should be strong.

Away from that, for those with subscriptions to RealMoney.com, I had an article published there that explained how to size portfolio positions. This article was inspired by Rob Pollock, the CEO of Assurant, who encouraged me to read “Fortune’s Formula,” which is a popularization of the Kelly Criterion.

Full Disclosure: long DOW YRCW AIZ

Worth the Fuss

Worth the Fuss

Posted on by David Merkel

I would like to draw your attention to this free Wall Street Journal article on Dan Fuss of Loomis Sayles. Dan Fuss is a fundamental genius in bond investing, and anything you hear about him is worth reading. Largely because of his reasoning, I own a decent slug of Canadian bonds for my balanced mandates.

I will contrast him with the better known Bill Gross of PIMCO. PIMCO is largely a quantitative shop, implicitly writing out-of-the-money calls against their fixed income positions to generate incremental income. Dan Fuss makes big investments on what he believes the world will be like 3-5 years out. His view of the world has been uncanny for several decades. No surprise that he has been the best in bond management over the long haul.

Let Them Eat Yield!

Let Them Eat Yield!

Posted on by David Merkel

An article in Friday’s Wall Street Journal described the creation of new closed-end funds dedicated to the production of yield. I am simultaneously horrified at the concept, and yet wondering whether I couldn’t create one with multiple strategies to smooth out the difficulties of single strategy yield creation. I could buy:

  • unusual bonds with high yields.
  • certain fixed income closed end funds at a discount.
  • dividend paying stocks, and occasionally (ugh) preferred stocks.
  • non- or low dividend paying stocks that fit my eight rules, and sell out-of-the-money calls against them.
  • lever the fund by borrowing at LIBOR.
  • Use my mean reverting REIT, utility, LP strategy. Backtests have it generating a 20% return annually, and I haven’t tweaked it.

The thing is, though, yield is a conceit. People like to think that they are merely scraping the income off of the portfolio, when in many cases, they are truly consuming capital, but the accounting doesn’t make it look that way. Think of a high yield fund with a single-B average credit quality. During good times, the full yield, and maybe a tiny amount of capital gains comes into income. During bad times, the yield shrinks, and capital losses get passed through. Over a full cycle, the NAV of a high yield fund shrinks.

Logical people would not invest in income vehicles like that, but invest they do. Two parting bits of advice. One, there is no reason to ever invest in a closed-end fund IPO. Closed-end funds should trade at a discount equal to the annual fee times five (or so). Two, be conservative in yield investing. It is little known that lower yielding REITs tend to outperform higher yielding REITs. The only time to stretch for yield is when everyone is scared. Even then be careful; make sure the yield that you are getting is secure.

What I Have Been Doing Lately

What I Have Been Doing Lately

Posted on by David Merkel

Recently I have had rebalancing trades, selling a little Dorel Indsutries and Sappi. Also, I swapped Sonic Automotive for Group 1 Automotive early on Tuesday. I was able to enjoy two unexpected sell-side upgrades. It’s not supposed to work this well, but it is nice when it does.

On another note, from a piece by Lloyd Byrne of Morgan Stanley, in 2006 only 73% of oil production was replaced by new reserves for companies that they follow. This is just another reason why I am overweight energy. The replacement ratio has fallen for the last four years.

Finally, if you subscribe to RealMoney, be sure to read Jim Griffin’s post, Fed-Watchers Have Blinders On. I have been contending that the housing lending crisis is serious but will not derail the economy on is own. With the decline in the dollar, it is no surprise that our exporters are seeing some growth. Funny that few notice that. I guess we are used to being importers only….

Full disclosure: long GPI DIIB SPP

Your Money or Your Job! (Or Both!)

Your Money or Your Job! (Or Both!)

Posted on by David Merkel

I must admit to being unimpressed with Sam Zell’s bid for Tribune. I can’t remember the last time someone put up so little money for so great an asset, aside for when I was the juniormost member of the AIG team considering whether to take over The Equitable. (AXA walked away with it, and the untold story is how AIG botched the whole thing.)

The skinny is this: Tribune the company borrows money, and gives it to the ESOP [employee stock ownership plan] to buy up the shares of Tribune. Sam Zell provides a small amount of subordinated financing ($325 million) to Tribune to help make this happen, and receives a warrant to purchase 40% of the company for $500 million. If the true value of the company is $8 billion, this is one sweet deal for Zell. Imagine getting interests in a company worth $3.2 billion, and only having to put up $825 million for that right.

Now, Tribune in its soon to be levered state might not be worth that much, to Zell, or to the employees. This deal presumes a lot in terms of the future profitability of Tribune. Will they be able to carry the debt load?Those that have read me for a while (at RealMoney) know that I am a bear on the newspapers, and most non-internet media businesses. The internet is destroying the margins that support newspapers in three ways:

  • Classified ads are more effective over the web
  • Advertising on the web is more targeted
  • Why subscribe to a paper, when the data is freely available online?

Now in each area a newspaper is still useful, but enough erosion occurs to ruin the economics. I doubt you can turn around a newspaper; perhaps you can create ancillary businesses off of proprietary content, but try to get people to pay for it, or stream a ton of traffic to get ad revenue.

As for the use of the ESOP to finance the takeover, it puts a gun to the heads of employees, who can only vaguely affect firm performance. Any value that they had built up in the ESOP is now at greater risk. If they succeed, they could make quite a bit (while Sam Zell makes proportionately more. If Tribune fails, the ESOP will be worthless, for any who were relying on it. (I realize some older workers can diversify some, but that’s not enough.) Sam Zell would lose his investment, but he can afford that easily. The proportionate impact to workers whose largest asset might be the ESOP would be much worse.

If I were a Tribune worker, I would urge the ESOP to vote down the deal. The downside is more significant than the upside.

The Pips Are Squeaking

The Pips Are Squeaking

Posted on by David Merkel

Around the world, broad measures of money are moving higher as goods price inflation moves higher.? China and India come to mind here.? Economic liberalization has brought benefits for both the nations that liberalized, and those that trade with them.

As such, tightening measures by developing country central banks are to be expected.? As an example consider this article by Andy Mukherjee of Bloomberg.? There’s a lot of excess credit out there, and central banks are half-heartedly trying to extinguish it.

Goods price inflation is moving higher globally, and global short rates are rising as a result.? When do we hit the tipping point, and what nations/sectors will have the worst of it once deflation or stagflation takes hold?? I’m not sure, but those that are running a current account surplus should do better.

Update on Indicators, Part 2

Update on Indicators, Part 2

Posted on by David Merkel

I should mention that Assurant has been added to the S&P 500. Could not happen to a more deserving company; they are truly innovators in the insurance industry.

And now, more on indicators, bullish, bearish, and otherwise:

Bullish

  1. Low quality stocks outperformed in the first quarter, according to Merrill Lynch. That’s bullish in the short run, but not the intermediate term.
  2. LBO volume and private equity volume continue unabated.

Bearish

  1. Economy feels like stagflation-lite. Low positive growth, and rising inflation.
  2. Inflation is rising globally, particularly in India and China.
  3. Mortgage interest payments in the US are a record high (since 1989) compared to Disposable Personal Income.
  4. Corporate credit metrics are deteriorating for both junk and high grade corporate debt, but are not critical yet.
  5. Equity REITs seem to be rolling over.

That’s all for now. Tomorrow is another day.
Full Disclosure: long AIZ

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