BAM buys OAK

Last week two companies I own decided to merge, creating a new alternative assets behemoth. Brookfield will buy out OAK shareholders for $49 or 1.0770 shares (equivalent to $49/1.0770 = $45.50 per BAM share).

My stake in OAK was 75% larger than my stake in BAM. So superficially any acquisition should make me happy. However, I am somewhat disappointed as an OAK shareholder (estimate IV ~ $55), and think BAM got the better deal here.

The deal is almost certain to close by 3Q 2019. According to the normal calendar OAK is due for a ~$1/share distribution in May. I haven’t decided whether to take BAM shares or cash (perhaps by selling before the close). My last BAM buy was in December 2018 around $37.50/share, so I am not overjoyed about having to pay a price near the TTM high. However, if the conversion is tax-free then then it would probably make sense to take the swap, since my cost basis in OAK is near $40.

Update: A nice initial take on the acquisition

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Some Links: MKL and BRK

  1. Semper Augustus with an annual update on Berkshire (among other things) suggesting an IV of $265
  2. A thoughtful valuation of Markel suggesting an IV less than $1000.

As outlined in my first post on MKL, I use three different valuation methods.

The first (most conservative) method gives me a value of $834 by using the leverage ratio (2.1) to determine an appropriate P/B ratio (1.28) to apply to BVPS ($654).

Modeling three separate units using updated numbers for premiums ($7864), invested capital ($19,238), Ventures EBITDA ($170) gives me a value of $1165.

Finally, the two column method, which is the most aggressive method, adds the net investments/share ($1168) with a suitable multiple to capitalize Ventures earnings (~$100) to arrive at $1266/share.

The average of these three is $1,090. An 80% discount would imply a buy price of around $900. Note that the IV seems to have fallen by about 10% since the last valuation.

Objectively, 2018 was not a good year for MKL. and 12/31/2018 may be a bad day to measure BVPS; its probably up meaningfully since the last reckoning.

Charter Update

Andrew Walker, who publishes some of the best analysis on cable companies including Charter, has a bullish update on his blog. He argues that CHTR is undervalued despite the 35% run up from its lows near $250 less than an year ago to ~$340 today.

I amassed a 4% stake at approximately $300 over 2018.

For 2018, CHTR had a FCF of ~$7B (EBITDA – CapEx) on about 235M shares out for a FCF/share of $25-$30. At current prices this implies a ~12x FCF multiple. This is attractive, but just the tip of the iceberg.

Given the ramp-down in capex, increase in EBITDA, and the guidance regarding debt ratio, it is quite conceivable that in 5 years the FCF/share doubles. As excess FCF is devoted to buybacks, the number of shares can get cut almost in half. This is not as ridiculous as it sounds at first. Over 2019 itself, CHTR is poised to devour about 10% of itself.

If the FCF yield remains the same this implies a 4x increase in share price (keeping up with increase in IV). This implies a IRR of 25-30%.

Even if you haircut the estimates, factor in a recession etc., it is hard to see how CHTR does less than 15-20% over the next five years.

FaceBull

Facebook reported better than expected earnings last week, and the stock, which was languishing in the $130-140s for a few months moved sharply up to $170ish.

Last year it earned $7.57/share, and had $41 net cash per share on the B/S. Ex-cash it still trades at a P/E of 20, which is probably low for a company that is still growing topline at more than 30%. It is also building an enormous moat by spending heavily on capex (and buying political cover), which is currently harming margins.

It is my second largest position (10% position). My effective buy price is $159.

Here are bull theses which go a great job of sizing up the opportunity:

Portfolio Review 2018

2018 was a drama queen. She went up and down, up and down, and up (?; one trading day left). We got our 20% correction; volatility came roaring back; and after a long period  of slim pickings, the orchard seems ripe with opportunity.

At the end of 2018, my top 10 holdings, after cash (18%), are as follows:

  1. BRKB (13%)
  2. FB (9.2%)
  3. FRFHF (5.2%)
  4. OAK (5.0%)
  5. WFC (4.7%)
  6. TCEHY (4.7%)
  7. CHTR (3.9%)
  8. MCK (3.8%)
  9. MKL (3.7%)
  10. JEF (3.6%)

The numbers in parenthesis denote the percent of portfolio. Collectively, they constitute nearly 3/4 of my current portfolio.

Four of the top ten holdings (bold) are new positions for me. Let me run through what my current “position” on the top six (4%+) of these holdings is.

I will write up the other four some other time.

I expect BRK, FFH, OAK to thrive in a downturn. Sure, they will go down with the stock market, for sure, but they will emerge stronger at the other end.

 BRKB

I believe the IV is somewhere near $250, about 20% higher than current prices. Given their large cash hoard, relatively defensive posture, and flexible buyback policy, I like Berkshire as a top weighting going into 2019, with whatever traps or opportunities it brings.

Berkshire started the year at around $200, swung +/- $15-20 over the year to end up roughly where it started.

I added 25% to my already large position, at around $190/share, earlier in the year.

FB

This is a new one for me. Facebook has been absolutely hammered this year. Despite its increased CapEx, FB remains an insanely profitable company with a significant growth runway. It trades at an average (market) multiple, despite being an above average company in terms of growth and return on capital.

My relationship with FB is complicated. Personally, I stopped using the app sometime in Feb-March 2017. I haven’t felt the urge to reactivate. But perhaps I will in 2019, just to see if it has made progress on facilitating a less combative/superficial environment.

FB started the year in the mid-$180s, dropped to $160s, when I started writing some puts, only to blast off to $220, before collapsing to the $120s in December. I started buying perhaps too early; my effective buy price is around $160, although that might shift since I’ve been exploiting the volatility to sell puts and calls to back into my final position size.

Fairfax Financial

FRFHF started the year in the low $500s and dropped to $485, when I promptly added about 15% to my position. I saw it rise to $580 in mid-June, patting myself on my back for being a genius, only to be humbled as the stock fell to $420s in December.

The BVPS as of 9/2018 was $421. At current prices, the stock trades nearly at book value. Prem Watsa has said that he think the stock is worth a lot more than book value. I haven’t added in the recent downturn. Nevertheless, Fairfax plays an interesting role in my portfolio. It offers exposure to Africa and India. It has a reasonable cash position, and would survive (thrive?) in a downturn.

OAK

When I last looked at OAK, I believed it to be worth north of $50. Oaktree spent most of the year in a rather tight range between $40-$45. I took to writing some puts when it approached $40, but didn’t meaningfully add or subtract my position.

OAK needs bad stuff to happen to sow seeds. It is in the aftermath of market crashes that it flowers. This year, finally, there is increased volatility. As interest rates rise, weak companies will succumb to increased debt payments. In their ruins, Oaktree will find value. Right now, I just enjoy the fat 7% dividend. In 2018 alone, I collected over $2k in distributions.

WFC

Wells Fargo, along with many other financials, got slammed in the last quarter of the year. I added 50% to my position, and have several puts out. I think Wells is worth about $60. Along with FB, this is probably my best “safe” idea.

TCEHY

Tencent is a new “big” position for me. I started buying slowly around $48, and scaled into my final position near $35, for an average cost around $40. At one point, the stock had been cut nearly into half its 52-week high near $60. It has recovered somewhat in the last few weeks.

Tencent is a dominant company in a geography (China) that the rest of my portfolio has (had?) very little direct exposure to. I believe that over reasonably long time frames, Tencent ought to return a respectable double-digit compounded return.

Update: CFX

So CFX is buying DJO Global for $3.15B. At prevailing prices of $25/share, the market cap of CFX is $3.1B.

This acquisition is a merger of equals.

CFX put out an investor presentation outlining their thinking and vision. Part of the investment thesis in CFX is good operation and capital allocation.

There are things to like and dislike about this merger. On the plus side, there is improved diversification, superior margins, higher growth, and less cyclicality. On the negative side, there is integration risk elevated by the level of leverage.

The company has outlined a path to deleveraging, including disposing off its A&GH unit.

Before the merger, CFX was expected to earn $2.20 – $2.30/share this year. At at 15-18x multiple (good management in a cyclical, low margin business), it was probably worth $33-40/share. Given the 123M shares out, this would imply a value of $4.15-4.95B.

CFX is paying 12x EBITDA for DJO Global (adj EBITDA = $269M). Its peers in the Health Care Equipment & Services sector trade for mid to high teen multiples. So the price CFX paid doesn’t seem crazy, especially given the $800M in NOLs that they inherit.

The TTM FCF (EBITDA) for the combined entity is $650M ($767M). At the current share price of $25, the market is valuing CFX’s FCF at a 9.5x multiple [9.5 * $650M – $3.15B)/123M ~ $25].

If CFX can sell A&GH at a decent price, they can delever and improve overall margin. Then the 10%+ FCF implied in the current price appears attractive.

Update: WDC and JD

JD and WDC have both been cut in half over the course of the year.

In this 3Q 2018 Commentary FPA Capital Fund look at the bear case on WDC more closely. They lay out the four main drivers of the bear thesis and “rebut” by claiming:

  • this NAND cycle is different
  • gross margin declines are real, but expect them to be more muted
  • stock price bounces back before EPS bottoms
  • company now has a buyback budget

Hayden Capital in his 3Q 2018 Letter to investor provides an update on JD:

  • Richard Liu’s corporate character is at odds with his personal character
  • JD is run like a military, and “lacks data-driven creativity”
  • Long-term thesis is intact; growth is strong, especially if margins head in the right direction.
  • Backing out Logistics and Finance, the core retail operation is trading extremely cheap.