Tuesday, 13 December 2011

why did RBS fail? my notes from the FSA report.

After a tiring day I thought there would be nothing better to do than read and take some notes on the FSA's report into RBS's failure. They are not comprehensive, the full 452 pages are here; FSA report into why RBS failed

7/10/08 RBS funded by Emergency Liquidity Assistance from the BoE.
13/10/08 RBS £20bn rights issue, only 0.24% taken up by private holders, government the balance.

public commentary was that £40.7bn operating loss being the problem is inccorrect. Of that £32bn was intangible writedowns, which don't have an effect on regulatory capital.

"Only" £8.1bn of capital was written down.

end of 2007 had £68bn of reg cap + £12bn of rights issued raised capital, => £8bn would have been absorbed.

1) less capital than peers, therefore first in firing line (although later charts show HBOS was in worse position but Eric Daniels had a brain fart).

2) "excessively" dependent on short term funding (I use the inverted commas because, well the FSA didn't seem that bothered at the time and its NR report shows an even worse example they didn't care about).

3) asset quality concerns

4) large losses from credit trading

5) ABN amro "wrong deal, wrong price, wrong way of paying and at the wrong time"...

6) Systemic crisis.

under Basell III RBS would have had 1.97% capital ratio rather than the required 8%.

in sep07 when NR failed, RBS was still able to raise debt. thought they were experiencing a "flight to quality", really?!

customer funding gap for the whole of the UK system rose from being zero in 2000 to ~£750bn by 2008 in pretty much a straight line.

rbs had a big reliance on short term wholesale funding, even when it was levering up to buy ABN it paid in borrowed cash of less than 1yr term.

ABN effectively doubled their trading book; that only required £2.3bn of capital for £470bn of balance sheet assets. from which they took £12.2bn of losses.

FSA make a big deal about losses on credit trading, because they believe that this causes a loss of confidence, in both the institution and the system which leads to recession, which leads to defaults. Sure tighter credit hurts the economy, but part of that is signalling. trading p&l for 2007,8,9,10 were; +1.3,-8.4,+3.1,+4.5. So over the four years they made £1.3bn.

Whereas losses from loans are £32.4bn.

credit losses were £14bn over 07/08. FSA make valid point that there was a lot of uncertainty around it though, which inevitably leads to funding issues.
credit trading pnl for 2008;
they lost 2.3bn on counterparty defaults; 0.7 Lehmans, 0.6 Madoff, 0.6 Icelandic banks
-0.6 CDPC
-0.6 principal finance
-2.4 structured credit
-7.8 "strategic assets unit" ?? is that a prop desk name?
-3.2 impairments
+2.1 commission
+4.0 interest
-4.4 staff costs - is that payouts from tinning people??

organic growth of the balance sheet was 24% p.a from 2004 onwards!

losses on loans over 08-10
Residential mortgages; £2.5
personal lending 4.6
corp property 10.4
corp other 9.7
other 3.2

IMHO their enormous quickly grown loan book is the issue, and the market knew that at the time and yanked their funding. They were too reliant on short term wholesale funding so they got stopped out.

ABN deal;
paid in cash, which they borrowed rather than funding with equity.

effectively doubled their trading book.

took the risk of being consortium lead, meant they had to consolidate the purchase and then split it up, and I think is the reason they got so much of conduit losses of abn assigned to them, because that was still being discussed in early 08.

thought that because they had integrated a same country retail deal that was bigger and had good reputation on cost control and synergies they would make a lot of money on the deal. described as a "vanity purchase", "didn't know what they were buying".

because deal was competitive and of a public company, due diligence was minimal, although that wouldn't have made much difference IMHO, they had similar risks on already.

rbs board unanimous and shareholders over 90% voted in favour of the deal.

no regulatory oversight of the deal on the UK end of it - Dutch were surprised by that.

there is a lot of discussion of management styles and processes, a lot of it is waffle looking for scape goats, and a lot more of it is hindsight trading. however there are some interesting issues;

RBS were slow to take their marks. Goldmans were really quick and good at this.

RBS used the 96% for their VaR, everyone else used 99.9%, how and why were they allowed to do this. Everyone else is planning for a 1 in 1000 even, whereas RBS are planning for a 1 in 24??

losses were 8x what their VaR models were predicting. The fact they are surprised by this was worrying. Little real stress testing.

Friday, 9 December 2011

saying No to Europe.

"interesting" comments from some European politicians.

Let us be absolutely crystal clear on a few things;
1) France and Germany have shown that they wish to implement a tax on the City of London that would be paid into EU coffers. As far as I am aware there is no other example of such a tax.
2) The treaty changes that were on the table will do nothing to change the course of the crisis, the idea that implementing a slightly stronger wording of deficit controls is going to change the solvency, competitiveness issues and lack of fiscal union is naive at best.
3) Even if this would work, there is no "bluff calling", if they are going to build a new version of the EU institutions that they are not legally allowed to use, it will take years not months.
4) Making a big fuss that the British are being obstructive is helpful, because it distracts both the markets and the electorates from the really big issue; the currency union doesn't work, the solution to fix it; fiscal union has no democratic support or legitimacy.

Parachuting in an army of Monti-style technocrats to run nations in the periphery, imposing German austerity, brings no guarantee of producing the reforms that will yield the vast improvements in competitiveness that are necessary for a country like Portugal or Italy to deal with the level of the euro. Regardless, the process will take years, look how long it took a rich developed nation (West Germany) to change a poorer one (East) when it had far more control, wealth and helpful global demand. It is easy to forget that German unemployment was at 12.5% in 2005.

Extremely high unemployment, a feeling of imposed austerity and loss of sovereignty and pride are a highly volatile and dangerous mix in Europe.

Imagine if China slowed down.

Monday, 3 October 2011

Timing a Greek default;

There are three main mechanisms that could precipitate a default;

  1. EZ and IMF pull future lending
  2. Greek banks face a domestic run on deposits
  3. Greece finally starts running a primary budget surplus and political cover allows them repudiate "odious debts".
(1) seems unlikely. Not because I believe that these institutions are committed or well organized, but because it would require action, as we have seen they clearly need a lot of prodding to do anything.

(2) would be very hard to predict as it is based on group confidence, so in modelling or thought process terms, its just a poisson process. 

(3) on the other hand *should* be easy to forecast. (well if one could have any confidence that Greek reported figures were accurate or not deliberately manipulated).

There have been several rumours that Greece has been inflating their budget deficit figures.

Their most recent projections however show that they should be running a primary budget surplus next year. In which case it makes even more sense that they promise reform programmes that kick in with savings in 2015 to secure immediate loans.

I am cynical so it is easy to speculate that Greece is deliberately trying to maximize the receipt of a fiscal transfer. What I find much more difficult to understand is the German position.

Many commentators have tried to explain their actions as 'pot committed politicians'. That it is just politicians trying to save their pride and hide the folly of their euro project designs. In reality the polls and general German media commentary actually suggests that not to be the case, that the population actually support some form of action, perhaps because they don't understand the true cost?

It appears to me that Merkel is deliberately obfuscating and is reluctant to face the consequences on ANY decision, be they supporting the euro, drawing a line in the sand, or turning their back. That is very weak.

Roland Berger published a plan which they called "Eureca". Which essentially said that Greece should take €125bn of assets (clearly overvalued for the purpose) and put them into a SPV in Luxembourg, and sell them to the EZ, use the proceeds to do a massive bond buy back. Then the SPV could be unwound, if the proceeds were lower than 125bn Greece would be liable to top it up, but would retain any upside if the assets were more.

There were some worrying features;
  1. Putting the assets in an SPV in Luxembourg really is meaningless, if Greece decided to nationalize the assets again International law would be pretty much useless, or they could apply huge tax rates to those assets and perform a defacto nationalization.
  2. Clearly this is just a secured loan, because Greece would still be liable for any shortfall, in which case unsecured creditors would still be wary on an ongoing basis of making new loans to Greece.
  3. For the assets to have real value rather than to be trophy assets, then they must have some associated cashflow, in which case the secured loan must actually have a cost, ie. If they include public offices, then clearly the SPV must be paid rent, in which case the improvement in fiscal position is a lot smaller than the headline figure.
  4. The point which was repeated several times that was most worrying however was the boast that such a plan would "burn speculators". Which they believed would cause spreads on the rest of the peripherals to collapse.
This last point just shows that they don't have a clue.

Thursday, 29 September 2011

FTT - Financial Transactions Tax.

Tobin's tax was designed to reduce volatility in the fx market.

Its also been suggested that the FTT, which would be a 10bps tax on stock, bond and derivative trades would be a good way to raise revenue.

Several commentators who really SHOULD know better, cite stamp duty in the UK as being a model.

Perhaps they'd care to look at the thriving CFD market, and the amount raised from retail investors and compare that to institutional investors? and reappraise their view! The tax simply does not work within the UK.

As to whether it reduces speculation? or volatility? well lets just say that if you think 10bps is going to stop somebody buying into a bubble or selling into a panic, well you need your head examined.

Thursday, 22 September 2011


the headline is a little unfair to the following link;

BlackRock Buys Junk Debt at Spreads Exceeding Bearish Scenarios

but there are several things that I dislike about it, as I commented on twitter;

1) the first is a general point. VALUATIONS ARE NOT AN INVESTMENT THESIS. Especially when you are comparing a risky number to a historical realization for a long term instrument. Yes it is appropriate to look at historical default rates, but to compare them to a risky market number is not. It is naive to ignore liquidity risk, risk of recovery, a market price to those risks AND then to forget about how short a sample of history one is looking at.

2) it is very consensual to believe that commodity producers and China are more stable. That the represent the future, and that Asia is insulated from the economic cycle. Although it is en-vogue to laugh at decoupling, there are more than enough people that treat it as a resting principle. The sectors that they proceed to say they are targeting demonstrate this;
"[the] firm is targeting bonds of speculative-grade companies involved in energy, mining, oil, natural gas, cable and wireless operations"


"You want companies that have more stable and visible cash flow streams, so their earnings quality is a lot higher and more stable to withstand economic downturns"

now these two statements are very much at odds with one another in my mind.

Mining, Oil, Nat Gas, these are all dependent on the industrial cycle. Sure you can see a mine, and see that there has been good historical demand, and that China had a massive fiscal stimulus, but to extrapolate that into the future isn't clear cut.

"a bubble is any kind of debt-fueled asset inflation where the cash flow generated by the asset itself—a rental property, office building, condo—does not cover the debt incurred to buy the asset."

I believe that he is talking about Chinese property in this quote from his interview with Bloomberg Business Week, but surely that applies to mines, oil and nat gas investments?

Sunday, 4 September 2011


There have been several people pushing the ideas of Karl Marx recently, from the FT's Alphaville, UBS economist George Magnus to the "neutral" BBC article that appears to have no author.


Marx was a terrible economist.

At the heart of Marxist economic theory, in fact I would say its central pillar is the Labour Theory of Value. LTV asserts incorrectly that the value of a good is the amount of man hours required to create it. So a portion of hot chilli con carne taking an hour to make is worth the same amount as a few litres of freshly squeezed ice cold orange juice. The most common objection is that Marx's theory is demonstrably wrong because it does not include input costs, ie. a gold ring is worth more than a silver ring. Marx took that simple incorrect theory and then proceeded to the conclusion that the difference between the selling price and the labour value of the product is the profit, which the bourgeois capitalists extract.

Marx doesn't really care if its by ripping off the consumer (I think because he believes they will act in self interest in a free market), but cares about the extraction coming at the expense of those providing the labour. He believes that the value that capitalist create is purely their ability to own the means of production enabling them to purchase labour at an unfair price.

In short, capital, capitalists, inventors and entrepreneurs only generate returns because they are in a privileged position to manipulate workers.

This is utter nonsense. If anything in a democracy it is labour that is able to manipulate the system rather than capital, witness the UAW or public sector unions destroying the fiscal position of their employers.

In our earlier example, the reason on a very hot day that cold orange juice will make a profit and the hot chilli con carne will not, is not because the owner of the means of production is able to bully his workforce, but because the decision to allocate capital correctly provided a popular and valuable choice to the market.

Additionally Marx makes some rather bold predictions that are neglected in the article above. According to Marx, what should be happening in the West is that profit margins should be falling, leading to companies cutting the pay of their staff, there should be mass over production of goods and chronic under consumption as workers purchasing power declines.

Instead we are now seeing very high profit margins, higher worker productivity and pay but weak cyclical demand. That really has almost nothing to do with Marx, other than the enormous sense of entitlement in large parts of Europe and a dollop of leftwing hunger to return to the rhetoric of class war.

What I personally find particularly jarring is the juxtaposition of the West, with a massive social benefits system, free education, health care, and living standards the highest they have ever been in the history of mankind, that is nominally a free market system, that consumes the enormous production of a supposedly communist country, with a much lower standard of living, poor working conditions, low/no employee rights, no benefit system, no state healthcare and pensions. Yet it is those in the rich west complaining that they don't have a big enough slice of the income and resources pie??

It is as absurd to claim the "system" isn't fair because your neighbour has a bigger mansion than you in Chelsea.

a little break down; from 27th April to now

Utilities  2%
Consumer Defensive   (3)%
Healthcare   (8)%
Communication Services   (11)%
Consumer Cyclical   (13)%
Real Estate   (15)%
Energy   (17)%
Basic Materials   (17)%
Industrials   (23)%
Technology   (23)%
Financial Services   (24)%

What is interesting to me is the return on technology, its very idiosyncratic given the relatively "normal" systematic returns that we see with the other sectors, ie. we expect to see utilities outperforming fin serv and cyclical industrials and base materials in an anticipation of a double dip/slowdown, I'm not sure/ well I didn't think that we would see such a dramatic fall in tech in the same scenario.

Looking at factor returns;
size  4.99%
value  15.81%
dividend  7.52%
momentum  9.42%
balance sheet   (0.43)%
"cloud"  11.62%
model  6.07%
conc. Model  6.97%

I find it even more surprising that the return on the balance sheet model has been so poor over the period. What does stand out is that the value and dividend models have performed very well over that time frame, to me that means that there has been a lot of relatively unsophisticated participation in the market before and after the sell off started.

The "cloud" factor is interesting as well, although mostly driven by the awful performance of normal tech.

I feel comfortable posting numbers like this because these factors are quite robust. Something often neglected much to the detriment of real returns in the long term.

Saturday, 3 September 2011

an interesting tax proposal;

Prof L.J. Kotlikoff presents an interesting tax reform plan; http://www.bloomberg.com/news/2011-08-31/a-tax-reform-to-kick-start-the-economy-laurence-kotlikoff.html

What I think is interesting is effectively shifting the burden on taxation onto consumption, rather than profits and income.

There are several questions I think need to be answered that are more practical than political;
1) LJK suggests taxing imputed rent; I think that is very difficult to achieve.
2) What revenue would this raise theoretically? and what revenue would it raise after one calculated the effects of normal avoidance schemes?
3) It would be interesting to see how much of the savings from tax return filing would be eaten up in the calculation of implied value of rent consumed?

Friday, 26 August 2011

management matters

Molins is nothing short of a basket case company.

Ms. Palmer-Baunack impresses me, Mrs T. would have been impressed with her handling of the unions in previous roles.

I like that.

If she can get a penny of value out of the company, then there are a couple of pounds of real value there according to the financial statements and a large dose of wet finger in the air.

dd in progress...

bank of america

its not a name i really care about. but i like to price things.

Buffett has stuck $5bn down, for that he gets pref shares that are worth $5.5bn, what is 10% between buddies..

the real KICKER is the warrants he gets, 700mm warrants that i think are worth $3.5, so $2.6bn.

in essence that means BAC is letting Buffett buy stock at a discount of 5/(5+2.6) it at 66c on the dollar.

BAC recently said that their tangible book value was $12.65

They just let Buffett buy the stock at effectively 36c on THEIR dollar if they think that $12.65 is fair value...

'yem kidding me.

Thursday, 25 August 2011

jackson hole

at the beginning of the week it was easy for some people to think that other people thought there would be one of these;

but anyone reading anything finance related will have realized that Bernanke is not going to play ball tomorrow, no dice.

there are not the same signs of deflation to justify the launch of QE3.

there is however the risk that Bernanke says the economy is weak and that they are keeping an eye on it. saying this would be a policy mistake in my view, even if that is what he thought. we have seen before the the market fears these sorts of comments because they think Bernanke can see lemons they don't have the data to see.

Bernanke is not a mug, i don't think he will make that mistake tomorrow, and therefore i think there is upside risk.

to balance that, today's price action was fugly.

Wednesday, 24 August 2011

Ian Dyson.

Another "Captain of Industry".

When in charge of Punch Tavers, had a basic salary of £675k.

Now that he has split the company in two and is managing just the profitable easy bit, has a salary of £675k.

If I did 30% less and got paid the same amount of money I would be pretty pleased. Especially if I got a pension contribution of 25% of that salary, a 150% bonus, £18k BIK. We're talking almost £2mm. The market cap of the company is £277mm, no thanks to management. That is a 73bps management fee!

I guess shareholders, not so much.

Tuesday, 23 August 2011

why didn't anyone look at the SMP balance yesterday?

well I didn't check how much the ECB bought of peripheral debt last week, and I didn't see any market chatter on the matter. The week before however there were millions of comments on that the ECB were out there buying €22bn.

Last week they clearly took it a little easier and only bought €14bn.

I think they only had/have the appetite to double the SMP, so they have €130bn of powder.

They don't expect to be buying once the EFSF is operational, although its not entirely clear to me when that will be, at first glance the earliest is in 4 weeks time, but it could be later.

That leaves them with €94bn. Which means they have the capacity to do €23.5bn a week.

OR they actually expect it to be longer, as the ECB clearly prefer the shock and awe approach. Their steady state approach will probably be more like the 14bn they did last week, which implies EFSF buying starting in 6weeks time.

Monday, 15 August 2011


No not something from a John Irving novel... but the Equity Risk Premium.

There have been several commentaries highlighting how "cheap" equities are versus bonds. In essence the ERP is the difference between the earnings yield, ie net profits / market cap for equities against 10yr government bond yields, ie the so called Fed Model.

Does one expect these yields to move in the same way though? in all economic environments? and does it provide a good signal?

Firstly one would expect these two yields to move in opposite directions, ie when the economy is improving, then bond yields should be rising as demand driven inflation rises and long term growth expectations rise, at the same time equity valuations are increasing so equity yields are falling. Whereas in a a recessionary environment the opposite will be true, bond yields fall and equity yields rise. Thus the ERP naturally is going to be counter cyclical, we expect it to be high during recessions, and low/negative in booms. However is it PREDICTIVE?

You tell me?

and would you bet on it?

any guesses for what those charts would look like in Japan??

Tuesday, 9 August 2011

quick notes again...

  1. August markets are thin. Any selling or buying can push markets to extremes far more easily.
  2. People have spent a lot of time talking about valuations, imho they really aren't that important, or supportive on the macro level.
  3. Profit margins are fat and inflated, probably meaning profits are 10-20% above their long term average.
  4. Reflexivity is going to bite, there is a big demand shock.
  5. Asia has a LOT of froth and bubble in it, there has been serious over investment.
  6. Government debt levels, demographics, etc are a long term headwind.

I'm not ready to run out and join the rioters and call for the end of civilized society, but it does look awfully gloomy, and that has been rapidly priced in. I've made some pretty decent money out of the move, calling how much further there is to go is a lot more difficult.

Monkey's pick bottoms. Its a lot easier to buy when its going back up than to catch a falling knife, etc, etc. cliches abound...

Wednesday, 3 August 2011

Arb trading...

A good proportion of the portfolio is dedicated to "arbitrage". Now, in the last few decades almost all relative value trading has been called arbitrage of some kind, ie. buying very 'cheap' value shares is now "time arbitrage". I use the term slightly more tightly than that, but more loosely than buying and selling exactly the same instrument, at exactly the same time for a penny difference in profit.

When I say arb, I mean things like merger arbitrage, credit basis trades, rights issues, convertible bond arb (with everything hedged!). These strategies are first order market neutral, ie. their pnl doesn't show any correlation to small moves in the overall market. They do tend to show correlation over big moves to the downside (which is what you really care about).

Some strategies have a fundamental reason for the weak downside beta. For example the probability that an acquirer walks away from a deal increases when the economy changes for the negative, the credit basis can often move in unexpected ways because of differing funding spreads and expectations of restructuring, etc.

In general there is also a second mechanism, liquidity and contagion. Holders of these arb, basis, RV trades tend to have similar positions and when the market takes a real beating there is often an increase in risk premiums and blow out in relative value spreads (whether fundamentally justified or not) as investors look to increase their liquidity. Additionally you can have real contagion as any stat arb fund that was around in 2007 can tell you, ie. a fund that runs several strategies blows up in one more directional one and then has to liquidate all their strategies, that can set off a cascade of liquidation.

The general point that came up in conversation however is that with all these type of arb spreads, one is short a put on liquidity. That diversification is an illusion, and if anything its better to panic first.

Thursday, 28 July 2011

nothing interesting to say, just some personal notes

  1. market very choppy, with a lot of negative expectation now built into the next couple of trading days
  2. any 'value' stock, or event stock that has even slightly come in under the whisper, ie. it might have beat analyst estimate but is below where hot money was wet dreaming for has been decimated, viz $aks, $stx, $mu, and I hope $gt tomorrow.
  3. it has only taken a week for the market to totally discount the EFSF bailout package, although the Greek PM is calling it the first step the an e-bond, Schauble is clearly saying that Greece is a special case. IMHO, as much as it pains me to talk about the market as some independent entity, "they" are going to gun it until there is cold hard cash, signed, sealed, delivered. Its not because of some evil conspiracy, but because holders of debt will slowly get more nervous the more they feel they are relying on political intent rather than legislation.
  4. Earnings commentary out of China has been mixed, half of companies have been very bullish, and half have been neutral, not that I expect corporates to see a hard landing before prices react!!
  5. Vol isn't elevated enough
  6. GBP is a sale, and gilts deserve to be smashed, the market is giving far too much credence to Conservative intentions.

Thursday, 21 July 2011

seagate q4 call notes

I have about three clips of this on, so my read is going to be biased whether I want it to be or not. clip one from when its deal was announced, clip 2 was a slow add on pull backs, and clip 3 was added yesterday as a punt on earnings. stock is down 11% amc, I was wrong and got my fingers burnt, mentally its very tempting to try to go through the call and find reasons that the market was wrong and to look for excuses, going to try to NOT be biased.

seeking alpha have the transcipt of the call, which I find very handy; seekingAlphaLink

$2.9bn revenue for quarter
$0.28 eps non-gaap
tam 166mm
32% market share
- believe june TAM is not inventory build but true demand
margin improved, not as much as they would have historically in this environment
*THAT* is the disappointment. they say because of four factors;
1) agreed pricing with OEM before demand surge
2) 'didn't achieve out time to maturity targets'
3) commodity price rises
4) able to service demand, but in lower margin segments

sold $600mm of senior unsec notes
sep tam think 165-170mm, $2.9bn revenue, see 200bp impact of commodity prices on margins, looking to offset them (but sound skeptical), also say that they'll look to pass them on.
r&d and sga @ $350mm
0.29-0.33 forecast eps

cerium oxide

q&a shows they aren't executing transitions well, and are wasting resources and tech -> not what I or the market expected.

Yes its disappointing, especially as its really execution failure when the market is presenting good opportunities, and if you're and investor like me, that bought the stock because of improving sector dynamics you're probably even more frustrated. It certainly marks down management in my books. What will enrage me is if management still take fat comp.

I messed up adding to the position yesterday. Am glad that I have sensible risk limits and will review whether to add based on price action today.

Wednesday, 13 July 2011

not something to look at before you try to go to bed tonight

government accounts

the total liabilities are £2.4trn. The 'assets' really aren't assets in the sense that they can't be sold without having to then purchase the use of them annually. 200% real debt to GDP is a harrowing thought.

Tuesday, 12 July 2011


Fiscal Union is muted as the silver bullet.

If only EU citizens will unite behind the idea of a Finance Ministry of Europe, all will be ok.

WHY? essentially because then NAG (Netherlands, Austria and Germany) will be able to permanently subsidize Greece et al, and then there will be no defaults.

Greece has two problems, (1) an unsustainable fiscal position and (2) an uncompetitive and contracting economy.

FU would solve (1), but shows why FU is impossible unless the FME has total control over tax and spending. German taxpayers can't and shouldn't vote just to hand over money to Greece, when they pay more tax, and work longer and don't have rampant tax evasion. German taxpayers should not be funding swimming pool tax dodging Greeks.

Greece has to solve its own fiscal hole, and to do that it must actually collect the taxes it tries to levy and to cut its spending. Public sector workers will moan that its not their fault, they should count themselves lucky that they got that unsustainable spending in the first place, rather than feel entitled to more.

Now (2) is harder. Many will argue that a fiscal contraction can only make matters worse, BUT, are having interest rates of 20% better for the economy?? NO WAY.

What has to be recognized is that the standard of living in Athens was unsustainable. It has to fall if Greece is to become competitive.

There are some that would now try to argue that if the EUR was much lower, then Greece would be competitive, however if that was the case, their purchasing power would be significantly lower, and so would their standard of living, the two are different sides of the same coin. Greece's economy is not sluggish because of Germany productivity, believing Germany should pay Greece for some of the benefit of having a slightly weaker euro is absurd nonsense. Germany could demand payment as recompense for having lower purchasing power.

Greece can devalue, but then it must accept a lower standard of living, or they can demand the same standard of living and become incrementally less competitive and watch the rest of their economy sink.

micro cap notes

FSTA:LN #56.208 @ 675p Fuller, Smith & Turner

Several revenue streams, managed pubs (£138mm revenue), tenanted pubs (£27mm), Fuller's beer sales (£104mm). I quite like London Pride. the numbers look pretty solid, with some good growth, and a decent brand, sensible organic use of FCF, opening up some small accomodation, spending on refurbs. In liquidation the firm would be worth ~ 540p, so there is a good floor to the valuation, its on about a 15x multiple, which is not cheap, BUT, it is well run and is a good brand. However the really bitter thing is the shareholding structure, they have three classes of shares.

A shares, listed on the LSE, which you or I could buy, in total have 58% of the economic exposure, but only 24% of the control, because the B shares effectively 10x the number of votes compared to their economic value, making up only 10.7% of the economic exposure, but having 65% of the votes. These shares cannot be sold on the open market, and effectively the families that still own these shares have first dibs on them if they come up for sale. Then there are the C shares, which are just like the A shares except they are not listed, but can be listed with 30days notice.

That puts me right off, I don't want to own a business and not have any say over it. Even when you get down to the liquidation floor, there isn't really that much you can do, because the family will want to continue to run the business.

Redhall group RHL:LN #29.589 @ 75p

hits nearly every red flag on my last list, absolutely terrible cash conversion, and appalling contract management. a bag full of semi unrelated businesses, being poorly run, with very little board level ownership of the stock, stay well clear. The Vivergo contract saga permanently excludes this stock from my investment universe.

Dignity PLC DTY:LN #54.757 @ 812p

without making jokes about this business, because I have a black sense of humour, it is important to note that there is a stable and increasing revenue stream, it is unlikely people are going to stop dying any time soon, so a funeral business does have some structural demand. The issue with this business is that it effectively has too little working capital for the expansion that it should be making, and is running too much leverage for my linking. Sure the cash flow is steady, but effectively £350mm of debt is too high for £72mm of FCF, because they need to invest £35mm to grow, with financing costing £30mm, it doesn't leave a lot for shareholders, so you're banking on growth, a lot less fun than picking up burnt cigarette butts. a fair value of ~ 827p being aggressive doesn't leave much meat on this one.

Molins PLC MLIN:LN #20.172 @ 109p

They've made what appears to be a good change of management, APB seems like a good pair of turnaround hands, and has taken a stance against unions with which we agree. Again its a mix of businesses, at least the there is a theme though, and the valuation looks ok, a 138p valuation doesn't look too difficult, thats 25% of good upside, without having to fight the tape too much one should imagine, especially as the balance sheet appears to give you a bit of a backstop. Need to do a bit more work on this one...

Monday, 11 July 2011

some red flags

  1. if a firm regularly takes out more than half of the actual costs to get "adjusted" earnings, that is a big red flag, especially if it is amortisation of goodwill, and they appear to want to create value with aquisitions
  2. they have slightly off key job titles, especially if its an engineering firm.
  3. very low shareholdings in the firm by the ceo and cfo, ie less than one years salary.
  4. low cash conversion on sales
  5. boastful and unrepresentative patter in the annual report, boasting about growing sales, when they've bought a business, and margins have declined, while paying themselves more; outrageous. 

sky falling in??

There has been more than enough ink spilled over the NOTW scandal; only a few points really need to be said;

  1. if hacking is institutional within NOTW, then it will be present in other papers
  2. the police's role is a much bigger issue, witness Guardian reporters getting information illegally as to where Coulson is being held, etc. venal.
  3. the attacks on news corp are politically driven, as are the attempts to block the bid for bskyb, the bbc moaning about too much media power is ridiculous.
so what though, none of that is going to make me a penny, the price action in b sky b (BSY) share may well do though. They've fallen about 150p down to 700p, what is the price level where one would take a punt then?

Well looking at the pre-bid price of 560p, the 30% return in the FTSE since the bid and the stock having a pre bid adjusted beta of 0.92 that would give 714p as the floor, which its currently trading through. There the very low probability that somehow Newscorp actually get made to reduce their BSY shareholding, or it becomes permanently blocked. Additionally the FTSE isn't a great index to measure BSY against.

Bottom up, fair free operating cashflow of ~£1,300mm, inc growth of 10% a year for the next few years, at we're talking about a forward multiple of ~ 11x, that's not too ugly a price.

Thinking of picking up a clip at 680p, with another at 570p.

The trade that has made money though, has been selling Trinity Mirror shares which popped on the news that NOTW was closing. If anything, from this point forward its only going to be negative news, without even looking at valuation we slapped out a clip this morning.

Friday, 1 July 2011

Jeffrey Sachs makes the Eurocrat case;


to paraphrase, Greece doesn't have to default if it has 3% interest rate, and breathing space and can magically get its economy growing again and cut its 18% deficit into a surplus....

if you punch all of those assumptions and hope into a model you'll see that the debt load is sustainable.

(red lines are historical data from Eurostat, that we've aggregated, blue lines are the forecasts with all of the assumptions above)..

It is a *little* rich for Mr Sachs to call those expecting a default naive, especially when the scenario that avoids default has so many conditions and unrealistic political movements.

I'll say it again, Greece will not default while they are still getting more loans, they'll borrow more money, but when the time comes for budget surpluses to be run, then they'll default and use the cover of the rioters and language of 'odious debt'.

Wednesday, 29 June 2011


When this came for IPO I remember being very interested. It is a fantastic product, and I can't see why most punters wouldn't use Betfair rather than their bookies once they have opened an account. It also has the critical mass and liquidity, given the fact that its pretty much the preferred exchange for spread betting firms to lay off their exposures, to give it a bit of a moat.

It does suffer from some serious negatives;

  • gambling as an industry should always trade at a bit of a discount because of the legislative and political risk that it faces.
  • lack of growth in its core market, it can really only grow its market share, as moving into different sectors it loses its edge, ie. its not going to grow a poker business or online bingo business, as they are competitive and will suffer serious and terminal margin decline
  • its going to struggle to break into different geographic segments because of regulation, and would need to get to critical mass
As such its valuation when it IPO'd was a bit of a mystery, we're now getting to the price levels where it gets interesting though;


What are fair numbers? and what is a fair multiple?

Firstly the firm has no real debt and has net current assets of ~ £46mm
A 'fair' EBITDA of ~£50mm, which you're fairly comfortable with given the business model.
what's a fair EV/EBITDA then? 10x seems like a fair stock exchange multiple => 510p

that's still a long way south of here, but one for the watch list if we do have a real sell off.

French Letter

here is the French proposal; ftalphaville link to french proposal

I think the mechanics in the flow chart are not too clear, here's my take on what happens;

Investor redeeming €100 of Greek bonds;
1) gets €30 cash
2) gets 30yrs on €5.5*0.7 + 0-2.5*0.7 risky coupon from Greece
3) gets a zero coupon bond, ZCB, worth ~ €30*0.7 today that will pay €70 in 30yrs time, that is guaranteed by the EU

Greece has to;
1) pay €30 to the investor
2) issue a ZCB to the EU for €70
3) pay coupons for the next 30yrs of €3.85 plus max(min(2.5,gdpRate), 0)*0.7

the EU
1) gets a zcb from greece
2) issues a zcb which gets held by the ecb

The euro value for the investor redeeming their bonds is thus approximately €78.

This is CLEARLY a restructuring. One can understand why a bank might accept it though, in part because of the dishonesty in the proposal.

  • Listed on an EU regulated market, but with restricted trading in the New GGBpg until 1st January 2022[1].

[1]    Trading and transferability restrictions do not apply to ECB financing transactions
This is trying to create a false market in these securities. By not allowing them to be traded they hope to make sure that banks will be able to carry on pretending that these bonds are worth this fictional amount. If I did that as a private investor, I would be sued for fraud, and rightly so.

I can accept that banks would accept this restructuring, because a 78% recovery rate on Greece is very high in my humble opinion. What nobody should accept is the idea that we can pay out such a high recovery rate from taxpayer funds, increase the taxpayer credit exposure, and be complicit in trying to create a false price for Greek debt.

When is the German public going to realize how much money they are giving to Greece?

Thursday, 23 June 2011


I get the feeling the market is already thinking about QE3 in a big way, and for some is acting as an insurance policy on their long equities/commodities/risky asset positions. Clearly this must be building valuations.

The more interesting point however are the second order effects of any potential QE3, and a question of its scale. IF it happens, and that is a very big if, it will be under some serious political flak, and as such its only worth then bothering doing if its a meaningful size, but clearly not going to be truly shocking and awe size.

QE2 had very wide reaching side effects; stock prices rallied hard, but more importantly, do did commodity prices, and food in particular. Another round of QE will put huge pressure on China, exporting inflation from the US to China in a big way. China will have to tighten, but even then, the political pressure from higher commod prices and higher food prices will have to lead to one of three outcomes;
1) substantial revaluation of the RMB
2) excessive monetary and fiscal tightening within China
3) revolution

(2) seems the most likely, but that is like somebody pulling very hard on the handbrake for the resource economies like Australia.

I am short $audusd, and doing a lot of work on Australian banks, and highly leveraged companies looking very actively for good short opportunities.

Tuesday, 21 June 2011

Labour overspending in a chart

Ed Balls still wants to pretend that it was just the recession that destroyed the UK's finances, well here are the figures from Eurostat. The chart is of the cumulative net spending as a % of GDP, so ignore where the finances are coming from, and focus on what government spent excluding interest payments versus their tax income, it is very clear that from 2001/2002 the Labour government significantly overspent, to the tune of  ~20% of GDP. The entire terms of the debate on the austerity measures would be so different if the UK's net debt was going to top out at ~60% of GDP, additionally we'd probably not be running such a large deficit.

So when Mr Balls calls for emergency VAT cuts, he really should answer the question as to why he fired that fiscal ammunition in 2003?

Friday, 17 June 2011

inflation and stock returns


is a piece by Warren Buffet from 1977, in which he talks about the effect of inflation on stock returns.

some interesting points;

But the potential for real improvement in the welfare of workers at the expense of affluent stockholders is not significant. Employee compensation already totals 28 times the amount paid out in dividends, and a lot of those dividends now go to pension funds, nonprofit institutions such as universities, and individual stockholders who are not affluent. Under these circumstances, if we now shifted all dividends of wealthy stockholders into wages -- something we could do only once, like killing a cow (or, if you prefer, a pig) -- we would increase real wages by less than we used to obtain from one year's growth of the economy.
The Russians understand it too
Therefore, diminishment of the affluent, through the impact of inflation on their investments, will not even provide material short-term aid to those who are not affluent. Their economic well-being will rise or fall with the general effects of inflation on the economy. And those effects are not likely to be good.
Large gains in real capital, invested in modern production facilities, are required to produce large gains in economic well-being. Great labor availability, great consumer wants, and great government promises will lead to nothing but great frustration without continuous creation and employment of expensive new capital assets throughout industry. That's an equation understood by Russians as well as Rockefellers. And it's one that has been applied with stunning success in West Germany and Japan. High capital-accumulation rates have enabled those countries to achieve gains in living standards at rates far exceeding ours, even though we have enjoyed much the superior position in energy.
This parallels to some extend our current situation, and should frame thinking towards government debt. Even though Krugman et al would like us to believe there is no consequence to government spending in a deep recession as there is no inflationary risk, it is still consumption, and by definition building up debt is the opposite of saving. By CONSUMING today, we reduce our ability to generate wealth going forward. Almost all government spending is really consumption, paying high wages, increasing future pension liabilities, hiring more equality officers, is all consumption, and dramatically reduces the countries wealth generation capabilities.


captures a lot of what I have been thinking....


Thursday, 16 June 2011

shopping list;

characteristics of stocks I would currently like to own;

revenue dependent on American business spending and consumer spending
cost of revenues largely dependent on commodity prices
no unionised labour, and low dependence on low skill workers
fixed rate borrowing, but generally low leverage.
plus all the usual requirements...

stocks I would like to short;

highly leveraged, floating rate
large fixed investments in commodities and supplying China

Wednesday, 15 June 2011

under the hood of a sentiment change

there has been a dramatic change in sentiment over the last month and a half.

the spy is down  -7.41%, iwm -10.11%, qqq -8.51%.

tlt is up +3.50%.

gld is down -0.86%

there have been many blog lines spilt on this topic, suffice to say, this has absolutely nothing to do with the debt ceiling, nothing to do with Japan, or Libya, and probably not that much to do with Greece either.

What then is driving this repricing? digging deeper than just the headline numbers;
size +1.20%
value vs growth +8.33%
momentum +1.69%
liquidity provision strategies +0.81% (unlevered)

consistent with the market shifting to more defensive footing in anticipation of slowing growth and macro economic weakness. My narrative is this; the commodity spike over the last couple of months hurt consumers, a small disruption to supply chains from Japan have undone a lot of the monetary policy heavy lifting of the last year. Demand remains weak.

What is not being talked about enough, is the tightening of Chinese monetary policy, and the risk that we see a hard landing there, which could seriously impact the commodity economies such as Australia. 

Tuesday, 14 June 2011

$CSCO, the wrong song...

Dasan commented that Barton Biggs didn't understand CSCO's valuation of 12x p/e thinking it could grow at 12% a year.

This is interesting, because Dasan is a very good tech investor, and I am not, my knowledge of Biggs as a stock picker is minimal, meh.... he does write a good book though.

I think if you are used to looking at beaten up industrials and searching for "value" you could make justify buying a whole handful of names; $INTC, $HPQ, $DELL, $MSFT, $PHG, all of whom have forward p/e's of under 10x, all of which have had positive top line growth over the last year, and three years compounded, all have pretty decent looking balance sheets, and certainly let you feel safe and familiar.

What is an appropriate multiple for these sorts of companies, tired, almost utility like structures, with fewer growth opportunities I'm not so sure market like multiples make that much sense, neither do these companies have hard barriers to entry, or perpetual demand for their particular products like you do with a water company. For these names to be attractive, one might actually need to see deep value multiples.

Where does that leave CSCO? well firstly there are a few other stocks that look a lot better, but on a 5xadj ttm p/e and adding in the spare cash on the balance sheet $3.86 + 5x1.32 = $10.46

So we are a long way from where I care...

Saturday, 11 June 2011

em-dm... am?


Interesting article in the FT, basically suggesting that by many metrics, EM emerging markets, have progressed to be close to or at the level of the DM, developed markets. More interesting than the history is the prediction that high savings rates in EM's will moderate, creating new demand, and that capital flows of recent years will reverse, ie capital will flow from DM to EM's.

Perhaps though there is another category that one will need to classify economies, and that is AM, ageing markets, such as Japan and parts of Western Europe, that will probably have a very different dynamic to that of developed markets that don't have the same demographic challenges.

Saturday, 4 June 2011

update on trend following in a bubble

This is a chart of the a simple trend following strategy sharpe, on the x axis is the time window used for the entry and exit signal in trading days, the green line is the sharpe for commodities and the red line is the sharpe for equities bubbles. These sharpe's do NOT consider transaction costs. Including that would dramatically shift the optimal window to a the right, because you'll trade less often. So the pseudo optimal window for commodities is the 6yr average, and for equities its a lot shorter, at the 252d approximately.

That would have bought you gold at $300 in 2002....a 17.46% compounded annual return. It would also put your robust stop at $866 now, a pretty huge drawdown.

Friday, 3 June 2011

another potential chinese fraud;


without commenting on the company in particular, its another example of a potential fraud. It was striking reading an FT alphaville article quoting a Chinese 'expert' saying that he saw long term problems for China, medium term problems, but had faith in the government to engineer a soft landing. There has been an enormous shift in media and 'expert' thinking that has blind faith in the Chinese government and the Chinese development model.

US officials have decades of experience and collective wisdom managing a market economy, one which is smaller, has more transparent and reliable data, yet one would be called mad if one were to place that level of faith in the US government to guarantee a soft landing. Or even more absurdly, that the Fed could fine tune the economy by setting interest rates to the nearest 0.01% (Chinese base rate is the absurdly precise 6.31%), when the Fed has to move in 25bp increments at least.

Fraud typically really starts to accumulate in the late stages of a bubble....

Wednesday, 1 June 2011

why the eurocrats think that re-profiling Greek debt will work.

I started off yesterday, with another post about Greece, it was boring....

digging through the numbers it just becomes so clear that Greece fudged its way into the euro. Greece ran a primary budget surplus of 3.62% before joining the euro, and then really just let it all hang out and since has been running -2.47%, whereas over the same period Germany ran 0.27% and 0.34% respectively.

Greeks' not paying high real net tax rates is not a new thing, preEuro (pE) tax revenues as a % of GDP, 39.64% versus aE 39.21%. So it really is the spending side of the equation that has made all the difference; going from 36% to 42%. ie having a Northern European welfare state, but also low taxation, and plenty of EU funds.

It has been incredibly puzzling that European ministers believe that reprofiling will sort out what I believed, like other commentators, to be a solvency crisis.

After the 90% net debt to GDP, its a when not if case of default, and lets call it default not modification, restructuring, etc.

Banks might be willing to pretend that a reprofiling (ie saying you can have your money back in 20yrs rather than 10yrs) is not a default, but a zero coupon german government bond would go from 71 to 51, a 30% haircut. Banks that have this crap in their "banking book" should still be able to pretend that there isn't a loss.


can Greece reach a stable equilibrium without default?

In eurocrat world, the answer has been muddled.

Under what parameters does Greece avoid blowing up?

Its current interest payments/total debt outstanding gives us the average interest rate which stands at 3.83%. Germany at 2.87%, so the credit spread that Greece "feels" is only 130bps. Even at that low level it was forced to ask for aid.

Believe it or not, it managed to feel a credit spread of only 56bps on average since joining the euro, instead of the 329bps before.

IF Greece were to reprofile, in terms of modelling that is just a guaranteed rollover of a bond into a longer maturity with the same coupon. BUT given that Greece is having to borrow to meet its coupon payments at the moment then it will still see some uplift in its effective average interest rate, unless it is given even greater access to EU funds.

So lets assume we lose our minds, and give the Greek government a pass, and assume they can bring their primary budget balance to a pre euro surplus of 3.4%, and that they have strong nominal GDP, what is the interest rate that avoides them spiraling out of control and needing to default. Well it looks like at about 600bps credit spread is the cut off point, above that and Greece is bust, below that it *could* turn its self around, if the Government managed to turn a 4% primary budget deficit into a 3.5% surplus over a few years, with very high economic growth. THIS IS WITH REPROFILING...

without reprofiling....then that stable credit spread is only 450bps.

assuming the market lost its mind and allowed Greece to roll its credit at current spreads, in less than 5yrs half of Greece's increased tax revenue would be spent paying the interest alone.

Thursday, 21 April 2011

why you're not listening if $wdc earnings disappointed you...

the company has been guiding the market, telling you that the eps is going to be lower because of overhang, clearly margins were not great.

our notes from the call;
tam ~165mm, they shipped 49.8mm down 2.5% y/y (industry 2.3%). $2.25bn sales ~ BR asp $45.18 (-$6 y/y)
demand next quarter seasonally weak, however because of earthquake supply disruption should create a supply shortage.
2.5 inch shortages greater than shortages in 3.5 inch.
..sounds to BR that WD is going to try to win share as other suppliers are disrupted..
gross margin 18.2% (25% y/y) (19% q/q)
r&d ~10% of revenue @ $252mm
net income $142mm 0.62 eps (0.66 non gaap) run-rate-p-e ~15.

is there a signed purchase agreement with hitatchi? its in the 10q
samsung-seagate, does it change the way you talk about your deal with regulators? ... no. still going to say merger is going to better serve customers, benefits of scale will be shared with customers.
intel expect low double digit growth, what is your oem colour? 2010 industry shipped more than end demand, too much inventory in channel, two year growth rate will be about 12%, 18% in '10-'09, so low growth this year.
any indication from oem's about hit aquisition? customer reaction has been very positive.
customers asking for more supply, do you ask for higher price, fixed orders, etc? work with customers for years, have flexible model, consistent, if their costs are higher, they share them, BR yes.
thought there was 8-10mm excess TAM, there was then a shortage in cpu in quarter, but they are pretty much back where they started. will take a full year to not be supply contrained for june, sep, dec get to equilib.
does toshiba have the ability/will to invest? their press release says yes
that is very significant piece of information that we've missed! need to find that ASAP...

BR thoughts; samsung-seagate deal is definitely a negative for the merger, its not positive. Toshiba deciding to invest is VERY negative, and need to find the press release that is referred to on the conference call.

reduced the position substantially until we find that toshiba press release and have a bit more of a think...

tactics for a bubble

what is the optimal strategy for taking the most money out of a bubble situations.

number one has got to be not trying to call the top, any strategy that is long during a bubble and plans to sell out based on some sort of valuation ratio is almost always going to fail if its truly a bubble. when a bubble is in a truly frothy expansion, participants are piling in because they're afraid to miss the boat, not even a greedy fool can predict that actions of an even greedier crazy fool.

there are good academic papers that point out that a bubble is characterized by "log periodic power laws" lppl. basically, the price goes exponential, the rate of return increases with time. which in itself fits with observation and with the process that is happening, the higher short term returns attract more investors, who push the asset higher, which creates higher returns attracting more money. clearly this is a situation where momentum is increasing and calls for a trend following strategy.

as such a good strategy would be to pick a moving average of an appropriate length say 100days, and to own the asset when it crosses above that price and to stay long until it falls below, and hope to liquidate there with as little slippage as possible. the Raven has backtested this strategy with stock data from the nasdaq bubble and if he remembers correctly the best window to use was the 200day simple moving average. additionally this has the advantage of being rather robust and minimizing on trading costs. the shorter the window length, the more trades and the sooner one is stopped out of a trade, but the less risk one takes.

update of the numbers for some famous bubbles coming up....

Tuesday, 19 April 2011

WDC pnl update

Looks like there is going to be some further consolidation within the industry, again, if this passes through trust issues then its great for margin and overhang.

$WDC reports tomorrow night, and it should be a very interesting call; perhaps now is the time for a p'n'l update of the trade put on last month, and as a picture is worth a thousand words;

just to put some numbers on that trade, thats a 15% return in a month and a half, where the stock position is being hedge with a index hedge...

here is a description of why; http://blackraven999.blogspot.com/2011/03/awesome-hitwdc-reaction.html
and here is a description of thoughts on the risk; http://blackraven999.blogspot.com/2011/03/wdc-risk-managing-position.html

Friday, 15 April 2011



a really good article in the wsj last month on unions and the right to work legislation.

eurozone defaults

There were rumours on Thursday that Ireland was going to choose to default, t'anks to an article in the Irish press that suggested there really was no other option for Ireland.

  1. What is being suggested is a selective default we'd imagine, so only foreign creditors take losses. Not cool, retrospective legislation to allow this modification of creditor seniority makes us feel very queazy. Spineless Stigtits will tell you that creditors will forget about it soon enough, however to rational investor, its a huge stain.
  2. Politically this has got to be easier than writing cheques to profligate nations that cheated their way into the euro? easier to bail out the Landesbank than a Greek citizen retired years before Klaus can even dream of taking a break.
  3. It is not a given that a country defaulting would have to leave the euro, although one would imagine that it could actually be better for all parties involved if that was the result. A country like Greece can devalue back to competitiveness and set its own interest rates. Sure this will leave JCT red faced sitting on some chunky ECB losses, but he's going to have a red face no matter what happens.
  4. Ultimately all the debt above 60-90% (60 being the Maastrich debt ceiling, no really...) of GDP for the piigs is going to end up on the NAG's books.

a nice talk by Richard Koo, but....


google will show you the way to his recent talk at the "Instituted for New Economic Thinking", Soros's talkshop.

Koo makes an interesting point, that with a balance sheet recession, because collateral is so far underwater (Japan and the US now after the bursting of their property bubbles) the private sector will reduce their spending in order to deleverage. But akin to the paradox of thrift, that "saving" (paying down debt) reduces the aggregate net demand/income, which leads to more "saving". He highlights what an enormous drag this could be on the economy by pointint out that Japan could have shrunk by 10% a year because of this were it not for fiscal stimulus.

He runs aground in our mind when he says that there is a lesson for Spain in this example. If there was an excess of saving taking place in the economy surely long term interest rates would be much lower? For a country like Ireland to keep a fiscal stimulus it would be needing to generate 15% returns annually on its "investment". As has been said before, at this point the plight of the piigs has a greater parrallel with countries trapped on the gold standard.

Unless there are going to be fiscal transfers, then default really is the only option, other than a great depression without an end in sight. The single biggest problem with fiscal transfers is moral hazard and the political implications for any leader signing that cheque.

Tuesday, 12 April 2011

punch interims update


Punch interim results with some detail of splitting of Spirit.

Market likes this... not so much, down 5p to 74.5p.

Spirit has 798 managed and 554 leased pubs, will move all over to managed or sell them.
Rev; £379mm (331mm managed, 48mm leased), ebtida £67mm (45mm & 23mm) and OP of £49mm (27mm and 22mm).
Managed business performed strongly, revenue growth of 2%, op growth 12%, whereas leased had falls of 5% and 7% respectively.
More exposure to London and SE, thats attractive as London seems to be quite decoupled from the rest of the UK as we saw today being the only area with rising houseprices in the UK.

Punch (rev, ebitda, OP; £277mm, £137mm, £130mm) going to split into core and turnaround divisions, currently has 5,241, of which 3000 will likely be core, which make up 75% of the ebitda. average income of ~£80k, 95% on "substantive agreements". Turnarounds on ~£40k, 2,300 pubs. expect to sell them over 5yrs at a run rate of 500/yr.
sold 160 in the first half of the year, @ £40mm which had ebitda of £1.1mm.  (so average selling price is 250k, if they are turnarounds on 40k income that is 6.25x) (BR: what happens to the debt for these pubs though???)
concessions running at £2mm a month for reduced rent, have also made £17mm of capex over h1.

took a £370mm impairment charge on the carrying value of non core assets, £81mm goodwill write off, turnaround estate being valued now at £278k per pub, 8x their ebitda.

net debt £3,079mm from £3,277mm

more later....

some market macro quick thoughts;

bull points;
1) rates are still low, Bernanke has still got his chopper out
2) the rear view mirror still looks good for the US and Germany
3) although people are talking about 'extreme bullish sentiment' there does appear to be quite a bit of short term fear

bear points;
1) china has been tightening and its not got much press
2) consumers have been squeezed by commodity prices
3) profit margins are historically very high, and there are long term risks for both wage demands and potentially higher commodity prices

Monday, 11 April 2011

Vickers report....

There are still calls for banks to be broken up along the lines of "casino" and "utility" lines.

This just doesn't make any sense.

Firstly is lending a utility activity? well if it is then there will be an enormous amount of risk in the "utility" bank, after all there was no investment banking involved in blowing up bradford and bingley, northern rock, hbos, or even rbs. It wasn't prop trading, or underwriting, commissions from equity trading, m&a advice that sank these banks, but having too many bad loans against too little capital.

Lets pretend that we can then put loan making into the risky "casino" bank, or perhaps suggest we seperate banks along three lines, deposit taking, lending, and investment banking. The businesses that are lending institutions will still require capital to lend, they are not going to be financed out of equity. In which case they will have to borrow money from.... dum dum dum... the utility banks, in which case deposits will still be at risk, unless the government is going to just guarantee those loans, in which case you've just double the business for accountants, auditors and regulators and not changed a thing.

The fundamental problem is that depositors make a loan, but they don't believe they are taking any credit risk, so take little to no care about the credit they extend, expecting the government to bail them out. The government has to charge for this, and the people to charge are depositors. However thats a real vote loser because the general public would much rather believe they were faultless innocent victums, rather than the greedy speculators they so love to castigate.

Tuesday, 5 April 2011

hmv warning AGAIN....

Another month, another ...

HMV warning

it appears that profits will be lower than "expected" at £30mm for the full year. (after posting an interim loss of £41mm)

last year it made £74mm for FY, with interim loss of £18mm, so a profit of £92mm for h2, whereas this year it'll be more like £71mm.

There are a couple of "highlights"; that they have pushed back the test date for their debt covernants, one would imagine that is linked to their announcement on the 25th March that they are board were exploring strategic transactions for Waterstone's and HMV Canada.

The stock reaction is rather telling, its so low it doesn't care, so the Raven will add a few shares to replace the few that he sold when the stock popped on that previous announcement. It is hard to imagine that there is anything other than bad news already priced in...

Sunday, 20 March 2011


A bank can trade at a premium to NAV, why?

because it can do things that as an investor you really can't; underwriting, m&a advice, borrow from the discount window, get bailed out, etc.

Imagine a bank, but without those pesky staff eating up costs, or costly office space, or the headache of having branches. Being a shareholder would be great, you'd be the one getting the bonus!

This was Tetragon Financial Group's pitch when they were listing this vehicle in 2007. The Raven was more than a little surprised that the bankers' could keep a straight face and although being on quite good terms with the chap at DB pitching this idea, he couldn't stop himself from laughing and hanging up when it was suggested that this should list at 1.3x book, "after all banks trade at a premium to that".

There were several features that made the TFG structure appealing at that time, however it was the funding that stood out; they highlighted that they had good terms to secure locked up funding from a couple of banks.. "evergreen loans" or something equally twee.

What really stank however was the idea that historical default and recovery rates were appropriate for the underlying paper, exactly the same argument as subprime, the banks making these loans and selling them were holding little interest in them, so clearly they would be of a worse quality than they had been when they were left holding the paper, for sure they weren't going to be better! The idea that the loans would be of a superior quality because they weren't making them for a relationship was utter drivel, the bank was still making them, and taking an investment banking fee, except now they didn't have to hold them.

The real sticking point is valuation. With a bank, they can grow their assets and revenue streams, they can provide services and run a business and as an equity holder that is your business, however much the folks on Goldman's renumeration committee think otherwise.

With TFG you don't have that, sure your assets can compound, but none of the growth in the business is yours, that all goes to the managers, who get paid as asset managers with a fixed contract that as a shareholder would be very hard for you to terminate. So in reality you're just an investor in a fund, except you're a permanent investor, you're signing up to paying those management and performance fees forever!!

One would have thought that the issue and frustration of gating would have made investors more cautious, especially to the idea of locking yourself into a credit fund.

So where should this trade to relative to NAV?

Well nobody should pay a premium to buy assets in a vehicle.

But we can see that you are contracted in to pay 1.5% management fee, and 25% performance fee above libor+2.25%. That 1.5% is guaranteed, so take it off as an annuity; that's 35% thank you very much. ie a muliptle of 0.65x book.

Currently NAV is ~ $10 per share.

It doesn't even take a Hedge Fund Manager on 1.5 and 25 to work out that a share price of $6.50 is 'fair value'.

Friday, 18 March 2011

buying puts as protection.

Buying options does not reduce your risk.

It substitutes some risks for others, you reduce your immediate price sensitivity and replace it with time sensitivity that is less intuitive and harder to manage for a normal portfolio manager. The lottery like returns tend to mean that buyers emotionally remember their winners rather than the thousands of small losers.

Selling options does increase your risk.

It introduces risk and pays a slight premium for doing so. Unless you have a very long time span, and enormous amount of wealth or are trading with OPM in a diversified and institutional setting, you are not going to capture that risk premium, and if you are a retail investor your commish will have turned that premium into a discount quicker than you can say inverted skew.

Howard Lindzon made a comment today (actually in Feb, have been meaning to finish this for a while) that is perhaps prescient; "after the run up maybe its time to look at buying some puts for protection". Having looked at this problem from more than a few angles while running a "tail risk protection book" for a two billion dollar multi strategy fund its one that has given the Raven a few black eyes and hopefully some robust insight.

Its almost always about the timing.

If you buy a boat load of at the money (ATM) puts and the market pukes, you're going to make money. The issue is that if you've got timing like that, well then who needs puts, just short the bugger and get your beach shorts ready because you're not going to have to work hard again.

The reason you buy puts its two fold; 1) not to get your face torn off by the market roofing it 2) which is very similar to (1) but to stop yourself getting stoppped out on a short. or 3) for implicit leverage, which is actually 1&2 together.

So you've skipped to the conclusion, bought your puts, and have been wearing your lucky underpants for the last month, the market is 5% higher and your puts are worth the square root of not a lot, the market actually does crack and you're mentally banking it, those puts must be worth something now, right? for some reason hitting shift-F9 is making no difference to your pnl??? WTF? what went wrong?

Puts don't give you the luxury of not having to get the timing right, if anything it complicates your pnl, introuducing even more timing risk and path dependancy. A "good" (read sucessful at selling centipeeds (a trade with lots of legs, which means lots of commission) to his clients) broker will handily pop up and suggest all sorts of options to sell against your put buy in order to reduce the "cost", by which he actually means the cashflow on day one, it certainley doesn't ever reduce the real cost, will show why it doesn't work in another post.

The paths that you will make money buying puts, you'd have made more money being short. The only advantage is that if the market has continued to go up you'll have lost more on your shorts.

So the first exploration in this space was to design a product that the Raven would have liked to buy at a reasonable price, ie some sort of look back put, ie a product that has a payoff equal to the (price at maturity - max price in lookback period). Well how much would that cost? and thinking back to the days of being on an exotic option desk, how would one hedge that with vanilla options? Without getting into too much fancy mathematics, or hedging strategy its just a good idea to think about what sort of paths will generate interesting payoffs;

1) close today is the market high and it sells off from today onwards, well then the price would equal an ATM put today
2) more realistically, the market rises, and then sells off, a basket of put weigted by the probability of that price being the maximum reached and the remaining time to expirary. so clearly the upside probability makes this product more expensive.
3) the best pay off profile would be a long period of a strong uptrend... with a '87 style crash on the expirary date.

Clearly there isn't a static hedge for this position, but its easy to think of a few dynamic strategies that would approximate that payoff, the simplest would be to buy an ATM put and slightly more shorter dated upside calls, using the profit from any move up on the upside calls to roll the strike in the ATM put up. One could also decide to implement a delta hedging scheme, which would be very similar to the portfolio protection scheme's that failed so drastically in '87. Any dynamic strategy in options is a wet dream for your broker, and a killer for your portfolio, you'll pay bucket loads of commission and for very little effect.

Statistically looking back these strategies would have cost about 3.5%, with a maximum upside profit of about 35% for 3 months of protection. The cost of which annualizes but your upside doesn't, so "hedging" your book would cost you 14% a year. One would have to believe the market has the potential to be a lot higher and the potential for it to be a lot lower, or more precisely that there is a large amount of uncertainty for these strategies to be worthwhile. In which case you're actively betting on volatility rather than actually reducing your risk.

The single best way to reduce risk, is to reduce all your positions proportionally.

Wednesday, 16 March 2011


Just two very simple points to make;

1) Before there is a bear market, generally, there have been positive fundamentals in place, ie. good corporate earnings that have been reflected in rising stock prices. Appealing to positive fundamentals is akin to pointing to the rear view mirror and exclaiming that there's straight road behind you, irrelevant if you're driving off the edge of a cliff.

2) Soros is right, the market and economy are reflexive. A fall in stock prices and a rise in credit spreads, will generally be followed by contraction in the economy for three reasons;
  • prices are a good forecast of future results.
  • prices reflect current sentiment, which in turn reflects future marginal economic activity.
  • prices effect the cost of capital which in turn effects spending decisions in the future.

Violent prices moves are only really "irrelevant" if they are corrected quickly.

Friday, 11 March 2011

$WDC risk managing the position

1) obviously we hedge, but what with? why? how do we calculate hedge ratios.
2) we have a stop, but of time or price? and where?
3) what position size is appropriate relative to the rest of the portfolio?
4) is there a good option trade to structure this better?

The most important thing is to be robust. Be roughly right rather than precisely wrong.

The natural hedge would be Seagate. We're betting on improving pricing in the hdd industry, shorting Seagate would remove that factor so a broad sector or index hedge is a better idea.

Calculating beta, ie the correlation between the stock and an index, has plenty of academic page space, the Raven uses his own special sauce, but it doesn't make that much of a difference.

Computer says... 1.5.

The nasdaq is a poor index to use as a hedging tool as it is very concentrated in AAPL.

We hedge to remove systematic risk, not add idiosyncratic risk, so a better choice would actually be a blend of indices, half spoo half nasdaq, looks robust enough, calculating a new beta to this... computer says..2.4raw 1.95net, the main driver of this high beta is the high volatility of WDC and relatively low volatility of the spoo. This suggests selling $0.97 of spoo and $0.97 of nasdaq for each $1 of wdc.

To be logically consistent we should have a look at the residual chart for $WDC, we at least have a history of the pnl of the trade that we are putting on rather than just looking at an outright chart, or using some rule that we don't have any feeling for.

It also allows us to at least estimate the risk in our hedged trade, as such for a $1 of wdc, we can expect daily moves of $0.04, with the worst daily move of -$0.38. These numbers are meaningless. A dollar of wdc is a dollar that could be lost. Theoretically it is possible to lose more, if the stock dropped to zero and the hedge rallied, but assuming risk of greater than $1 is over cautious and unrealistic. What it means to us is that we need to be cautious and not leverage the position, although many people would say that $1 of wdc and $1.95 of hedges is already leveraged. A reasonable stop would be a loss of 20% in price performance, and a reasonable stop in time would be 3 months.

3) Obviously this depends on what other positions are in the book, risk tolerance etc. What can be said absolutely is an upper limit on the position size, and that placing anything bigger would be a mistake. quarter Kelly betting criterion would suggest nothing greater than 5%. That is an upper bound.

4) Given that this isn't an event driven trade, ie. we are not anticipating a takeover, spinoff, rights issue, etc, then the value of using options is that they give us leverage and the ability to limit our downside. Without even looking at the vol surface, it doesn't make sense that we'd pay a dynamic hedger to take risk for us, when we actively want to take risk in the stock.

However, that might be worth a look later.

Wednesday, 9 March 2011

an awesome HIT..........$WDC reaction

Huge news monday morning, and would have had more to say here if there wasn't the need to trade it. WDC are buying Hitatchi's storage business, the ominous "third player". The stock moved from $30 on Friday to $36 a pretty huge move. Having been short the stock and spent the last two days first buying back the small short and putting on a proper sized long its fair to say this is a game changer.

Removing this pricing pressure from the market has an enormous impact on the multiple that one should value wdc and seagate on. Without the deal the pricing situation was bleak. A large number of units overhanging that didn't seem to get cleared a siutation getting worse because Hitatchi was looking for an exit, and in so doing was trying to push up sales at the expense of margin for a potential IPO.

It was quite plausible that the selling prices could have been knocked down a further 5%. Just using the trailing 12 months, that would have reduced sales from $9.9bn to $9.4bn, and net profit to $0.58bn from $1.09bn. Putting that on a conservative multiple of 8x (which is justified for such a cyclical business) and adding in the $2bn of cash and you were looking at a price of ~ $28, but obviously with a lot more downside if the economy got worse or Hitatchi really started to blow out stock.

Whereas if we put on our rose tinted spectacles and dream, then WDCHIT looks pretty sweet; the combined group would have about $19bn of sales, on an 21% operating margin and all the synergies, and then a move up to a better multiple of lets say 10x and we're looking at $2.6bn net profit a year and a stock price of $100. yes triple.

Being very conservative, lets say a 50% leak, half synergies, 18% margin and the same old multiple 8x and we're at $36. Mid case and we're talking $55.

Lets make it even more simple, there are essentially three cases;
1) deal gets kaboshed - stock drops, $27
2) deal goes through, no synergies, high leak, no multiple expansion $36
3) deal goes through, land of milk and honey, $55

You can play around with probabilities and try to be really smart and work out a finer detail on this, however in the short term one has to recognize that the future has radically changed, and that historically markets don't digest that information quickly.

The same human nature that allows momentum to be a profitable strategy is at work, its hard to buy a stock that has gone up a large amount in a short period of time. Here we see the reason why and that there is a lot more upside potential.

The Raven has bought his position already, but will continue to add if the price action confirms this view.

Tomorrow some more thoughts as to those relative probabilites and how we're going to risk manage our position.