Investing

I'm going to write some more about my 2009 forecast and 2008 results in a future post but here are some of the broad ideas. One of the key things I'm expecting is a substantial recovery in base metals, energy and broadly in commodities. This is simply because prices have fallen so far that the economy can do badly and still perform better than the market is expecting. I expect that:

• This will not be as bad or even nearly as bad as the great depression
• Prices have overshot to the downside, in part due to deleveraging
• The recent situation is unprecedented and the response from government and monetary authorities has been unprecedented this will bring forward the recovery in commodity prices (at least relative to dollars).
• The US Dollar is going to go down substantially once the deleveraging ends, this will be more like quarters than years
• US Treasury bond prices are unsustainable but may remain that way for some time. They are the short of the decade but you may not see any reversal in the next 12 months (don't fight the fed, the fed wants rates very low right now).
• Many stock are an excellent buy at current prices based on the underlying value of their businesses.
• The worldwide fiscal response is targeted at infrastructure projects this will add incremental demand to commodity prices while low prices in the later quarters of '08 have reduced supply.
• The major drop in asset prices was caused by credit markets seizing up, this problem is coming to an end (based on indicators such as the TED spread) though the economic slowdown persists. Half of the reason for the decline is resolved and asset prices will start to reflect this even while economies are in recession
• The stock market will turn in advance of the economy. There will be no economic news to indicate that stock prices are going to turn.
• Broad markets will probably retest their recent lows in the first half of 2009. It could be profitable to buy some insurance at today's and increasingly higher prices.
• Commodity stocks survived 7 months into the US recession and 10 months into the bear market. They are fundamentally unimpaired and will likely lead us out of the bear market.
• Bank stocks will likely do well over 2009 because they were likely priced for the end of banking. Unfortunately they are too complicated to analyse so I won't be touching them.

There are two great articles one from the WSJ and the other from Fortune by Ken Fisher which broadly agree with me.

As a value investor the right question about the above is so what! As Seth Klarman explains in Margin of Safety when you make macro calls you need to be right on the call, make it before everyone else does, make it before the market has priced it in, convert the idea into the correct trades, identify when the trend has become correctly priced and again trade out. This is vastly harder than buying undervalued securities of businesses and then selling them when they reach fair value. Therefore the only real take away is that STOCKS ARE CHEAP RIGHT NOW(especially resource stocks)!

I've likely lost between 10% and 25% on my AHUG investment which I've written about here and here.

In my last analysis I outlined the risks but left out the one that occured. Allco went into administration. There was an offer in excess of $45 on the table before that. The administrators have now negotiated away most of the money that was going to AHUG, to Allco's banks. AHUG holders will now get about $11.53 plus a share in the liquidation of the HIT trust.

The HIT trust had

• $9M in cash as of September 30th.
• As of 30th June they also had $58M in various investments offset against $53M in loans
• $2.8M in receivables and other assets.
• $6M in payables.

That would net out to $8.2 in assets or $8.47 per unit of AHUG. They would probably not realize that much but it seems unlikely that there would be less than $2 a unit.

AHUG holders are being asked to vote to accept $11.53 plus the residual in the HIT trust. For AHUG to be worth more lots of legal maneouvers would need to go well. They are:

• Trust applies to have proceeds of Alleasing sale quarantined while they try to enforce the letter of support (LoS)
  
• Trust receives leave from the courts to pursue the LoS
  
• Trust is succesful in enforcing the LoS form some amount.
  

If the trust could not get the monies quarantined then a succeful case would leave AHUG holders as unsecured creditors of Allco which is probably worth nothing.

I'd estimate the likelyhood of success here would value AHUG higher than $11.53 and i'm sure the receivers recognize this. Instead they are using the current fear to bully holders into a worse position. (This reminds me of deal or no deal where the banker offers an amount worse than your expected value but the fear of loss causes the player to take it).

I, for one, accept the bullying and will vote to accept the $11.53 plus the residual from the winding up of the HIT trust.

I'm left thinking that this was the perfect value investment. A good chance of making multiple times my investment (heads I win) and a small chance of losing a little (tails I don't loose - much). The actual chain of events was almost unforseeable back in August, yet the inherent margin of safety in buying 60c worth of assets for 17c resulted in a managable loss. This position has far outperformed the market since August!

Seven Networks (SEV) is the parent company of a number of entities including a joint ownership (47%) of the Channel Seven TV network. SEV has the following assets (per share based on 222M shares) as at 30 June:

* 1.2Bn in cash (5.45 per share)
* 1.2Bn in equities including 20% of WAN (5.45)
* 800M in Seven Media Group (the Channel Seven JV) (3.64)
* 25M in property (.11)
* Telys (prefered equity described below) (-2.25)

As of 19th September they gave an update on their equity portfolio and cash
* 1.3Bn in cash (5.91)
* 1.1Bn in equities (4.97)

There has been some discussion in the press about Seven Media Group (SMG) being essentially worthless because of their debt. They have about 2bn in debt and then effectively 1.6bn in equity split between KKR and SEV. They do not pass dividends back to SVN because all of their, currently depressed, earnings go to pay off the 2bn in debt.

SMG may be worth zero. In SEV's last filing before spinning out SMG they had 1.8Bn in assets of which maybe 1.4Bn are attributable to SMG. Net of SMG's debt, which is obviously NOT recourse to SEV, there may not any asset value. That 1.4Bn is at cost, though so property etc may be worth much more. There also hasn't been any dividends paid from SMG to SEV because all the cash is used to pay interest. It seems likely that there is still some value in SMG but a lot less than the $800M at cost.

Adding the most recent numbers up you get about 8.74 excluding SMG or 12.38 including it as valued on the balance sheet.

They have announced and are conducting a share buyback. They are repurchasing up to 40M shares and seem to be doing so below $6. Assuming that they repurchase 40M shares at $6 with the most recent equity prices you get:
* 0.96Bn in cash (5.33 per share)
* 1.1Bn in equities including 20% of WAN (6.08)
* 800M in Seven Media Group (the Channel Seven JV) (4.44)
* 25M in property (.11)
* Telys (prefered equity described below) (-2.76)

Which would be 8.79 without SMG or 13.24 including it.

SEV has no debt and isn't liable for the debts of those companies that it invests in.

There are also preferred shares (TELYS) outstanding trading as SEVPC. They are trading at 76.1c on the dollar and yield 4.564% on face value or 6% if purchased today and they're fully franked which is the equivalent 8.6% interest with no franking. They step up by 2.5% in May 2010 and are perpetual so they don't have to be redeemed. They have a 27% yield to maturity if they were redeemed on May 2010. The YTM is reduced to 20% if they were redeemed in May 2011. Of course they may never be redeemed in which case based on today's interest rates you'd get 10% before tax. The $496M of SEVPC outstanding could easily be redeemed with SEV's balance sheet though I expect it's not in the best interests of shareholders to do so at the moment. The SEVPC money is effectively paying for the share buyback.

Book value in July 2007 was 10.31 a share and the stock traded above that and as high as 14.46 (for one day) before the current retreat. SEV pays a 6.2% franked dividend while you wait.

Kerry Stokes is the major shareholder in SEV and he is likely to deploy the cash at rates of return better than cash. As he holds around half the shares outstanding you should expect him to act in the interests of share holders! There is an excellent interview in the Australian with Stokes where he clearly lays out, in April 08, that he expects media values to fall substantially and then he will become a buyer.

In buying SEV you get around $8.79 in cash and publicly traded equities, net of the TELYS, for $5.50 as of 4th December. Adding in a token amount for SMG you get $9.35. The equity portfolio likely owns shares that in turn are substantially undervalued. You also get the opportunity to participate in the upside if SMG's situation improves. Finally you get Kerry Stokes to find cheap media companies during a crisis with the 900M he deliberately kept for such an occasion -- all for free!