Sunday, September 30, 2007

How to get Super Returns?

Hi all,i came across this interesting article from the Business times,which is a local daily newspaper that reports about the ongoings in the local stock market and regional happenings.In this article, the author describes how one can use a simple ratio such as ROE/Price to Book to generate excellent returns.The method is actually a variation of Greenblatt's magic formula.

The article

"But without any detailed analysis other than simply grouping stocks based on ROE/PTB, I found that investors can actually generate super returns.

By investing in the 10 per cent of stocks with the highest ROE/PTB every year between 1990 and 2006, and holding each portfolio for a year, one could have turned $100 into $34,000 over the past 17 years. That's a compounded return of 41 per cent a year. All the calculations exclude transaction costs.

If we assume that the investor had lost 10 per cent of the portfolio value to transaction costs every year, the return is still a respectable 27 per cent a year. But in absolute terms the portfolio value today, at $5,678, is significantly less than the $34,000 which excludes transaction costs."

The full article is here


Saturday, September 29, 2007

Breaking down Expedia

Expedia came into my radar screen when i read the financial times. In it, Barry Diller, the chairman of Expedia Inc actually announced a 3.5 Billion share buyback plan which was to take place through a dutch auction. This would mean that 117 million shares approximately would have been bought back by management. This, to me was an extremely bullish announcement and prompted me to dig further. Buying back 42% of all share outstanding is a fantastic way to create shareholder value when the company is trading below its intrinsic value. It also is a catalyst for moves to the upside. Well, just to illustrate, Expedia's net cashflow per share is approximately $1.95(545 million/279million) and after a buyback, this would value the net cashflow per share a $3.4(545million/160million). This drastic change would largely enrich the existing shareholders of the company.

For those who do not know what expedia actually does, it is an online travel company that focuses on the needs of the the traveling community. It empowers travelers by presenting in capsule format information that allows people to plan and efficiently research their travel itineraries. Its products primarily consist of air, hotel, car rental, destination services and cruise. Essentially, it is an online travel agent which solves all your travel needs.

A brief look at its financial results are not actually that fantastic. It has shares outstanding of 279.33 million. Return on equity for fiscal year is 4.7% and return on assets are 3%. Net income figures are not fantastic and earnings yield are considered too low by any standards too. When i first did research on this company i found that it was trading at a price earnings ratio of 36, extremely high and does not seem like an exciting opportunity.

But what made me dig further was Barry Diller. As i have mentioned in previous posts that management is the one factor that will actually determine the value of the company. Management can bring the company down and they can cause stock prices to soar. Effective management is important for a company's survival and profitability. The motives of mangement can actually be found in some of the SEC Filings.

I did some research on Barry Diller and found that he was extremely bullish about the company's prospects. In fact, in one of the artcles which was written, he mentioned, if i may quote him that he is "confident in the value of expedia and its long term nature" Coincided with the buyback of 117 million shares, this guy must mean something. Furthermore, Barry Diller has affiliations with Warren Buffet. And he firmly believes in a share buyback when a company is undervalued. Do refer to this.. You might get a hint of his philosophy here :

A further look at his holdings made me excited. Barry Diller actually owns 24% of the company. Wow! Surely, there is this huge incentive for him to push stock prices up. The question is: Is there a margin of safety to be found in an internet stock. Is there really any margin of safety????

As it is, some of its competitors such as Travelocity, Orbitz and Priceline trade at extremely high multiples. For example, priceline traded at 53.7 times earnings when i first pounced upon it. If anything at all, staying away from the industry and the company would be the easier option. However, relative to its competitors, expedia does trade at an approximate discount of 40%.

A look at expedia's numbers suggest that the industry is actually still growing. From year 2004 to 2006, its diluted EPS was $0.48, $0.65 and $0.70 respectively. Its operating cash flow was 792 million, 859 million and dipped in year 2006 which was 617 million.

A look at expedia's cash flow also revealed that Net income was not reflective of the company's true value. For fiscal year 2006, its earnings was 245 million while amortization was 200 million. Operating cash flow was 617 million. This showed that expedia has got some hefty amortization charges and it almost felt that they were wishing to get rid of the amortization charges of the cash flow statement. Amortization was 230 million in year 2005. Clearly, the amortization charges were distorting the financial picture of Expedia. Also, a point to note is that amortization for definite lived intangibles was projected by management to be 78 million and 56 million for 2008. These numbers tell a story of financial engineering for if amortization figures do fall, this will make earnings per share increase assuming everything stays constant and if the market loves to value the internet companies based on earnings per share(P/E), this will be a boon to existing shareholders i feel.

So to sum up the picture:
1) Barry Diller is bullish about his company
2) The share buyback is a catalyst
3) This seems to be a case of financial engineering

Lets make some conservative projections for 2008(Assuming that the net cashflow remained on par to 2006). If earnings for 2008 was 245 million and amortization was 200 million and others being changes in working capital was 200 million, this would leave a net cash flow of 545 million if i do assume that investing and financing cash flow is a negative 100 million. After the 42% share buyback, this would cause cash flow per share to be $3.40. The industry's Price to cash flow is typically 37. Before the share buyback Expedia would approximately trade at a price to cash flow of 15 times.

Conservatively, if Expe traded at 25 times cash flow(which me and manpreet feel is not too demanding a cash flow multiple), the value of the company would be approximately $85(25 x $3.4) And this is ignoring any growth in cash flow that may result from the company's improved operations. Although growth of operating cash flow is expected to be at least 12% p.a for the next 3 years while taking into account the high cost of borrowing, there is still a possible growth in cash flow but for the purposes of conservatism it is extremely conservative to assume no growth in net cash flow within the company. Just for your information at this point, expedia earned $384 million ebit in FY2006 while it is projected to earn 697.8 million ebit in FY2007 . Hence, am i being super conservative in assuming a no growth situation. Yes! In a twist of events, Expedia decided to cut its share buyback programme to only include 25 million of all shares outstanding due to high cost of borrowing. This once again would affect the value of expedia. Recalculating the net shares outstanding after a 25 million share buyback, this would result in a net cash flow of $2.14(545mill/254mill shares outstanding) This would value expedia's price at $53.5 (25 x 2.14)

The price of expedia's stock was approximately $29 then leaving a 46% margin of safety. Me and Manpreet discussed and decided to scoop up expedia warrants(expez) at $17 a piece. Each warrant allowed one to purchase .969375 shares of Expedia, Inc. common stock at an exercise price of $11.56. Nearly every dollar move in the underlying would result in a dollar move in the expedia warrant. Whats better is that the risk reward ratio would drastically improve. For every dollar that i risk if i had bought stock, i might have only made a profit of $0.84 cents while if i had bought expedia warrants, for every dollar that i risk, i would have had the opportunity to make $1.44.(Upside of $53.5 - $29 stock price at which i bought the warrant/17) This made the situation compelling and we scooped the warrants up at approximately $17.

One last point to add though, it is so important to look at the motives of management. Poor numbers may not be poor forever. Things change. Management is the number 1 catalyst to stock moves to the upside and i cannot emphasize this more. John Malone was and still is a stakeholder in Liberty Media. For those who do not actually know his background, what he did was he turned 50 million into a billion in 2 years. How? Just by financial engineering through the spinning off Tele-communications while simultaneously pretending to not be interested in the spin off. Analyst shunned it for it was too difficult a transaction to understand. Numbers were also negative with liberty reporting a loss of $20 million. In the end the spin off took place and because John Malone had a large stake in these companies involved, he turned 50 million in 1 billion in just 2 years. Simple financial engineering. People wanto get rich don't they? For more, Do read Joel Greenblatt's book. Right now, John too owns a 23% stake in expedia and he is backing a new share buyback programme and things are beginning to be more exciting as it unfolds.

Sunday, September 23, 2007

Case studies by Sanjay Bakshi

Dear readers!

Check this out!

Better and better,

Thursday, September 20, 2007

Expedia Arbitrage

During these months of crisis, the market has taken a beating and most peopls's portfolios have actually been beaten down or affected without a shadow of doubt. Easily, most people might have suffered a 10% loss in the value of the portfolio due to the subprime crisis.

But if you do look hard enough, you can always find opportunities that can insulate your portfolio. For example, MCBF still remains an arbitrage play. It is currently trading at $11.90. Do refer to the link for more information

But what i would like to point to is a special situation that is probably not very much spoken about and which occurred very recently. Expedia came into our radar screen when Barry Diller the Chairman of expedia announced a 3.5 billion share buyback program. Essentially with shares outstanding of 279.33 million shares, buying back shares at a dutch auction price of between $27.5 to $29 dollars per share pushed the share prices right up as you can see from the charts above just before the middle of June. A dutch auction basically allows shareholders to tender their shares at the stated range and this will allow the company involved to buy back majority of the shares at the lower end of the rage depending on the prices which were tended. Now, this bullish announcement caused share prices to shoot right up from around $24 to $29. If all the shares were bought at $29 , a $3.5 billion buyback program allows the company to scoop up 43% of the company's shares outstanding which is an extraordinarily large amount of shares within the company. As it is, the Chairman himself Barry Diller owns around 22% of the company's shares outstanding and probably believes that expedia is grossly undervalued. This, i shall write about in my next article.

What happened next was that due to the high cost of borrowing money to fund the buyback, expedia cut their share buyback program by 80% !!!! Due to management's indecisiveness and lack of planning, the stock tanked to $25.75 in one fell swoop. Guess what? Management mistakes can prove to be pretty profitable at times. Here are the facts...

For one, the dutch auction will still take place at the stated range between $27.50 and $29. The only difference is that the share buyback program is only reduced to 20% of the original plan. To me a 10% share buyback program is still quite substantial and can prove to be a catalyst for moves to the upside.

The second factor is that since the dutch auction is still going to take place, the management is sending a clear signal to the market that the shares were worth at least $27.50 cause they were willing to buy back your shares at the minimum price of $27.50. Chances are that they would even buy it a higher price depending on the prices tendered by existing shareholders.

If you did the math, you find that if you actually bought those expedia common stock at $26 and held it, in just a month, it would have risen to $29 when the buyback took place. Today, expedia's price stands at $30. The profit is a decent 11% return($3/$26) assuming you sold out at $29. Even if you did sell out at $27.50, the profit would have been 5%($1.5/$26). Annualise those figures and you would have gotten a higher return.

One can always find opportunities like such. It is simply a matter of looking hard enough and being patient. This to me is like money from the skies, from the heavens!

Have a great day folks!

Better and better,


Monday, September 17, 2007

Saturday, September 15, 2007

Subprime crisis

The subprime crisis! Is it really a crisis?

Lets do some break down of what has been happening. The subprime market is basically the market of lending money to credit unworthy borrowers for their home loans. This group of people have poor credit histories and have often defaulted on their debts which makes this group of people very risk to lend to. Anyhow, the market values this group of people as higher interest rates are charged to them and hence these companies earn higher interest margins.

Well the market can actually be segmented into 2 types. There are actually fixed rates and variable rates. Variable rates have an inverse relationship to the housing index. When the housing index in US dipped, you find variable rates rising and hence leading to higher default rates which has led to the bankruptcy of certain companies.

Not all companies in the housing market offering subprime loans are affected. As a matter of fact and relativity, variable rates packages have been more drastically affected than fixed rate packages. Its not like the whole subprime market consists of only variable rate loans right? Is it a crisis? Not really in my opinion as the subprime market is only 7% of the housing loan market. Yes it has repercussions but me and manpreet actually believe that the whole subprime scare might have been overplayed. As it stands, The fed is expected to cut interest rates while Asia, remembering the impact of the Asian Financial Crisis has been building its reserves drastically. Also, in emerging markets, interest rates are on a down trend. Valuation levels in South East Asia remain attractive from about 8x to 17x from what i read in a report.

Hence, it is a fantastic time for bargain hunting people!!!!!

Better and better,

Sunday, September 09, 2007

Buffett Talk to MBA Students at Florida University 1998.

Excerpts from Buffett's talk to MBA students at Florida University

You were rumored to be one of the rescue buyers of Long Term Capital, what was the play there, what did you see?

Buffett: The Fortune Magazine that has Rupert Murdoch on the cover. It tells the whole story of our involvement; it is kind of an interesting story. I got the really serious call about LTCM on a Friday afternoon that things were getting serious. I know those people most of them pretty well--most of them at Salomon when I was there. And the place was imploding and the FED was sending people up that weekend. Between that Friday and the following Wed. when the NY Fed, in effect, orchestrated a rescue effort but without any Federal money involved. I was quite active but I was having a terrible time reaching anybody. We put in a bid on Wednesday morning. I talked to Bill McDonough at the NY Fed. We made a bid for 250 million for the net assets but we would have put in 3 and 3/4 billion on top of that. $3 billion from Berkshire, $700 mil. from AIG and $300 million. from Goldman Sachs. And we submitted that but we put a very short time limit on that because when you are bidding on 100 billion worth of securities that are moving around, you don't want to leave a fixed price bid out there for very long. In the end the bankers made the deal, but it was an interesting period.

The whole LTCM is really fascinating because if you take Larry Hillenbrand, Eric Rosenfeld, John Meriwether and the two Nobel prize winners. If you take the 16 of them, they have about as high an IQ as any 16 people working together in one business in the country, including Microsoft. An incredible amount of intellect in one room. Now you combine that with the fact that those people had extensive experience in the field they were operating in. These were not a bunch of guys who had made their money selling men’s clothing and all of a sudden went into the securities business. They had in aggregate, the 16, had 300 or 400 years of experience doing exactly what they were doing and then you throw in the third factor that most of them had most of their very substantial net worth’s in the businesses. Hundreds and hundreds of millions of their own money up (at risk), super high intellect and working in a field that they knew. Essentially they went broke. That to me is absolutely fascinating. If I ever write a book it will be called, Why Smart People Do Dumb Things. My partner says it should be autobiographical. But this might be an interesting illustration. They are perfectly decent guys. I respect them and they helped me out when I had problems at Salomon. They are not bad people at all. But to make money they didn’t have and didn’t need, they risked what they did have and what they did need. That is just plain foolish;

it doesn’t matter what your IQ is. If you risk something that is important to you for something that is unimportant to you it just doesn’t make sense. I don’t care if the odds you succeed are 99 to 1 or 1000 to 1 that you succeed. If you hand me a gun with a million chambers with one bullet in a chamber and put it up to your temple and I am paid to pull the trigger, it doesn’t matter how much I would be paid. I would not pull the trigger. You can name any sum you want, but it doesn’t do anything for me on the upside and I think the downside is fairly clear. Yet people do it financially very much without thinking.

There was a lousy book with a great title written by Walter Gutman—You Only Have to Get Rich Once. Now that seems pretty fundamental. If you have $100 million at the beginning of the year and you will make 10% if you are unleveraged and 20% if you are leveraged 99 times out of a 100, what difference if at the end of the year, you have $110 million or $120 million? It makes no difference. If you die at the end of the year, the guy who makes up the story may make a typo, he may have said 110 even though you had a 120. You have gained nothing at all. It makes absolutely no difference. It makes no difference to your family or anybody else. The downside, especially if you are managing other people’s money, is not only losing all your money, but it is disgrace, humiliation and facing friends whose money you have lost. Yet 16 guys with very high IQs entered into that game. I think it is madness. It is produced by an over reliance to some extent on things. Those guys would tell me back at Salomon; a six Sigma event wouldn’t touch us. But they were wrong. History does not tell you of future things happening. They had a great reliance on mathematics. They thought that the Beta of the stock told you something about the risk of the stock. It doesn’t tell you a damn thing about the risk of the stock in my view. Sigma’s do not tell you about the risk of going broke in my view and maybe now in their view too. But I don’t like to use them as an example. The same thing in a different way could happen to any of us, where we really have a blind spot about something that is crucial, because we know a whole lot of something else. It is like Henry Kauffman said, “The ones who are going broke in this situation are of two types, the ones who know nothing and the ones who know everything.” It is sad in a way. I urge you.

We basically never borrow money. I never borrowed money even when I had $10,000 basically, what difference did it make. I was having fun as I went along it didn’t matter whether I had $10,000 or $100,000 or $1,000,000 unless I had a medical emergency come along. I was going to do the same things when I had a little bit of money as when I had a lot of money. If you think of the difference between me and you, we wear the same clothes basically (SunTrust gives me mine), we eat similar food—we all go to McDonald’s or better yet, Dairy Queen, and we live in a house that is warm in winter and cool in summer. We watch the Nebraska (football) game on big screen TV. You see it the same way I see it. We do everything the same—our lives are not that different. The only thing we do is we travel differently. What can I do that you can’t do?