Tuesday, 12 August 2014

New News

I have finally left my post in the investment industry to branch off on my own.  Time will tell if I was insane for making this decision, but I am confident things will work out.

Nothing gives me more pleasure than significantly growing someone else's savings.  My value style is not complicated; all it requires is passion, diligence, and public information.

It will take several months to set up the business, at the end of which I'm planning to either cut this blog off or somehow transfer it to the new website. I realize that I have droned on about HHC in the past.  This reflects my obsessive compulsive nature when I lock onto a unique idea.  And the truth is that without the HHC opportunity, I would not be taking this step in my life. Yes, it was that hard of a swing.  

I have invested in numerous other spinoffs recently, including VRTV, RYAM, and POST, but have not been able to free up the time to write about them.  When the dust settles from setting up my business, I then must think about how to share and communicate ideas in a manner that does not conflict with the interests of my clients. 

Saturday, 17 May 2014

HHC Annual Meeting

I attended the annual meeting last Wednesday to listen in on the latest news. Though well attended, it was full mostly of employees.  There were only two questions during Q&A; both were from non-employees.  I would hazard a guess that there were fewer than five investors (outside of directors/employees) present.  Is it just me, or is it bizarre that a $6 billion company can stay so under the radar with the investment community?

Bill Ackman conducted the meeting and Q&A, and Dave Weinreb followed up with a few comments. One question from the crowd concerned the company's C-corp structure and whether Ackman thought a REIT conversion would be appropriate at some point. Ackman replied by saying that the C-corp structure made sense given the ability to retain and reinvest earnings. Also, HHC to this day has not paid much in the way of taxes given the net operating losses inherited by the company. Lot sales from MPCs and condo sales do not qualify under the REIT structure, but once core projects underway (e.g. Riverwalk Marketplace, Exxon build-to-suit office buildings) reach stabilization, the proportion of traditional lease-type income will significantly increase; Ackman stated that eventually the company may find itself in two different businesses and that a reassessment will be made to see what the optimal structure should be.

Sounds to me as though some kind of spin-off is imminent. The tax loss carry-forwards will be used up eventually, all the while office and retail NOI will gap up significantly over the next three years. By 2017, I estimate that office/retail income before tax could exceed MPC + Ward condo income. Of course, the margin of error is as wide as one can imagine in such a model.  The point is that a big percentage of income will soon be exposed to tax. 

Speaking of range of outcomes, management's success in their executive warrant scheme is ultra-levered.  If they are as money-centric as me, I lose absolutely no sleep over whether they will do the right thing.  By my calculations, the value of Weinreb/Herlitz's shares if a net settlement were to occur today would be $260.4 million. That's right - a 15 bagger so far!   In layman's terms, a net settlement is a way for management to exercise a portion of their warrants without expending cash from their pockets.  HHC did this to cancel Brookfield's warrant position in late 2012, and the same can be done here.  My estimate shows HHC (at today's price of 145.90) could repurchase ~900K warrants for $93 million from Weinreb and Herlitz.  This would leave the two with enough money to exercise warrants for 1.8 million shares for $75 million and still have $18 million remaining, which would be required to settle the capital gains tax from the sale of the 900K warrants. It goes without saying that the net settlement won't happen today - it will be transacted when the share price is higher, which will put management in a position to realize an even bigger ownership stake from the swap.  Somebody sign me up for one of these deals!!  The only problem is I lack the secret sauce that these guys have to create the value! Heck, these guys have made me lots of money, so how could I complain anyway?

I am not aware of management's intentions, but I don't see why they (Ackman/Weinreb/Herlitz/Richardson) couldn't rinse and repeat the whole thing again in 2018.  The two big x-factors at the time would be where the housing market is in the cycle, and whether they are up for doing it all over again. With a split-off transaction, the MPCs and remaining development properties could be placed into Newco ("HHC Developments"?).  The remaining HHC can convert into a REIT and lever up in order to provide Newco some cash to start off with.  Newco will also be self-sustaining out of the gate, provided the housing market doesn't go into another dive.  An exchange ratio will be set; management can backstop the offering and also have an oversubscription clause.  Ultimately, the transaction will allow interested parties to transfer their interest to Newco, and the exchange will dub as a buy-back for remaining HHC.  If I'm correct in my speculation that Weinreb/Herlitz have an intense love the development game, Newco will make complete sense in two ways: (1) Allow them to focus their time on developing commercial properties. Remaining HHC will in a few years become too big and bureaucratic for their liking, and (2) By maxing out their exchange to Newco, which will be smaller in market cap, their wealth can compound from a smaller base (i.e. escape diminishing returns from law of large numbers). 

Disclosure: The author still owns all his shares...and recommends those on the border of selling to keep delaying that decision.  Do not be a slave to your NAV models; when a large component of the investment outcome hinges on successful deal making, basing your sell decision on cash flow a few years out is likely to give you the wrong answer.  Rather, focus more on the insiders and how they maneuver their ownership stakes around future corporate action. As a wise-man named Joel Greenblatt once said, "it pays to follow the insiders"

Sunday, 9 February 2014

Reflections on Thinking, Fast and Slow

My apologies for the long absence. Sometimes life gets busy, and other times it gets incredibly busy. Such is the case when your day job consistently occupies 13.5 hours per day (due in part to a long commute), compounded by family demands. But enough whining... the good news is that the day job involves investing, my favorite hobby. It is safe to say though that what I do during the day does not overlap at all with any ideas presented on this blog. As for the commute, it is a net positive given the round trip provides a solid hour each day to read anything of my choosing.

I recently finished Daniel Kahneman's "Thinking, Fast and Slow".  It is essentially a psychology book published in 2011 that a number of people referred to me. The interesting thing is that I don't know anyone else who actually finished the book. I suspect this is because the content is somewhat akin to a text book (i.e. not conducive to scanning), and at nearly 500 pages, not a quick read.

The book is worth buying because it will give you awareness of certain psychological tendencies we have as human beings that sometimes lead to bad decisions. The key finding is that everyone makes decisions based on their subconscious ("System 1") and more rationally through calculated thought ("System 2"). Although it was not written specifically for investing, the direct application of several concepts is striking. For example, one chapter goes through our tendency to take quick averages. This applies to sum-of-parts type investments, where opportunities present themselves because the market throws a multiple over a company's net profit instead of determining the value of each segment.

As an illustration, assume a company's income is $100mm but is a sum of $200mm from Division 1 and a loss of $100mm from Division 2.  A price of $1,000mm would equate to 10x earnings, but assuming that Division 2 could in the worst case scenario be shut down, you are effectively paying 5x earnings for Division 1 and getting Division 2 for free.  This would have been the basic gist of Brookfield Residential a few years ago, when the stock price at $6.50 implied you are paying less than the intrinsic value of the Canadian division and getting the U.S. assets for free. A current example would be News Corporation, which in my estimation trades at a 30%+  discount to the sum of its parts.

Other concepts that I thought are particularly applicable for investors are:
  • Anchoring: The tendency to be influenced by numbers seen in recent memory. An example you may be familiar with is the over-use of comparable multiples, or relative valuation. This leads to the market underpaying for entire industries for prolonged periods, and conversely overvaluing them later on. 
  • Loss aversion: When agony associated with realizing a loss outweighs the positive feeling of achieving an equal gain (e.g. -$50 vs. +$50). This can lead to irrational follow-up decisions, such as doubling down when unwarranted, and/or setting up a mental account for the stock in question. By keeping a mental account for each stock (as I have been guilty of doing in the past, and still do), we are prone to taking profits on winners while waiting to breakeven on losers before moving on.
  • Overconfidence: How important is luck in determining our investment results, or life in general? Howard Marks discusses the importance of being lucky in a recent write-up.  For me, luck played a role in almost every big life decision, from becoming interested in Buffett, to being told about the HHC opportunity by a friend months before the spin-off, to meeting my life partner, to my choice of school... the list goes on and on. By not crediting luck enough to past successes, we become vulnerable to overconfidence. And overconfidence in turn will lead to errors such as overweighting investments without doing the necessary due diligence, or leaving a high-paying job to start a sole proprietorship without having realistically weighed the odds of success.

My personal belief is that psychology is just as important to being a good investor as anything else. Had I read this book sooner, I would have recognized a mental error (excessive loss aversion) sooner and saved myself an amount that works out to >1,700x the cost of the Kindle version... and that is assuming I took only a 50% loss on that particular mistake (instead of selling at -85% last week after reading Kahneman - ouch!)

Disclosure: The author owns shares of Brookfield Residential and News Corporation.