Monthly Archives: February 2013

Salem Communications reports 2012 results

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Salem Communications reported the results for fiscal year 2012 yesterday. At first sight the numbers don’t contain big surprises. Adjusted EBITDA is for Salem Communication a decent measure of the business performance relative to previous years, and with Adjusted EBITDA down 0.4% I think it’s clear that nothing really big happened. It’s a pretty stable business.

What is worth mentioning is that the company has launched a tender offer to buy back the $213.5M in debt that has a 9.63% interest rate. Salem is offering 110.654% of par, and that more or less seems to be a fair price considering the fact that the debt would have been callable December this year at 104.8% of par. Refinancing the debt could increase the free cash flow that the company is able to generate significantly. Last year it generated $21.3 million in free cash flow after paying $23.4 million in interest expense. We’ll have to see at what rate SALM will refinance, but there is a lot of room to improve the FCF yield (currently at 13%) by reducing the interest expense.

Disclosure

Long SALM

Austrian Economics: the FED created the poker bubble…

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As a professional poker player and as someone with an interest in economics and finance you’ll get my attention when I see an article called “Monetary Origins of the Poker Bubble“. In the article the author, a proponent of the Austrian school of economics, makes the argument that the poker boom was caused by the FED due to artificial low credit rates. Cheap credit entice businesses and individuals to spend money, and if it’s too cheap it could potentially create a bubble. It’s probably a good explanation for the US housing bubble, but I think this is far fetched at best to use this as an explanation for the sudden popularity of poker. I’ll try to explain the main flaws in his argument one-by-one:

1. Don’t underestimate the Lollapolooza effect

The author dispels the notion that the introduction of televised poker with hole card camera’s and the story of Chris Moneymaker were the main ingredients to fuel the poker boom because hole cams were introduced in 1999 on British television without causing the poker boom, and before Chris Moneymaker won the main event it’s popularity was already rising. Charlie Munger is known for using the term Lollapolooza effect to describe multiple factors acting in the same direction to explain explosive outcomes. I think that’s exactly what happened with poker. The introduction of hole card camera’s, the possibility of playing online, Chris Moneymaker grabbing headlines were all factors that worked together to make an explosive growth in popularity possible. The author, Peter C. Earle, writes:

But fads and surges of popularity come and go; these explanations hardly account for why, in a short amount of time, tens of millions of people suddenly flooded into a familiar—indeed, 150 year old—American card game, frenetically expending tens of billions of dollars on it.

The poker boom wasn’t a case of a 150 year old sport that suddenly skyrocketed in popularity because credit was cheap. It became not only for the first time in it’s history a good spectator sport, it was also the first time you could play it easily online from your home. Throw a good story on top of that and you have an explosive mix. I also doubt that the 2003/2008 period was the first time in the history of poker that interest rates were low. So why didn’t we see a poker boom somewhere in the past?

2. Was it a bubble?

I’m not the only one to criticize the author, and he actually already addressed some concerns in this blog post. The author asserts that the explosion in poker’s popularity was a classic speculative boom. I’m not so sure about that. Did we have a Fifty Shades of Grey bubble the past years? Is there an Angry Birds bubble? I don’t think anyone is going to answer yes on those questions. The books and games are consumption goods, and just because they are popular for a limited time doesn’t mean that it’s a bubble. Poker is the same: it’s not an asset class that you can speculate on, it’s entertainment. If it’s popular people spend more money on it, but nobody is buying poker chips expecting that they can resell them a year later for more money. A lot of people buying poker books doesn’t make a bubble.

3. The poker ‘bubble’ didn’t burst in 2006

The biggest issue that I have with the article is probably the fact that there is little reason to believe that the poker bubble burst in 2006. So not only do I think that there is no causation between low interest rates and the popularity of poker, I also don’t think there is any significant correlation. On Poker History we can find some data on the peak number of players online in a given month:

Total Peak Players - All Networks

Looking at the above graph it seems hard to argue that the poker boom ended in 2006. Only after the United States Department of Justice pressed charges against the three biggest online poker operators on 15th April 2011 we see a big drop in activity, a day known as Black Friday in the poker community. Regulatory developments are a way better explanation of the popularity of poker than interest rates. The big drop in people participating in the 2007 WSOP Main Event, used by Earle as an argument that the poker ‘bubble’ deflated simultaneously with the housing market, is also explained by regulatory developments. In 2006 the UIGEA act was passed, resulting in the exit of PartyPoker from the US market. At that time PartyPoker was the biggest online poker site, and a substantial amount of players were send to the live tournaments through online satellites.

The fact that a number of poker shows stopped broadcasting in the 2006-2008 time frame is also a poor indicator for a bubble bursting. Those shows were sponsored by the online poker sites, and with a number of them withdrawing from the US market due to the new regulations it’s not a surprise to see some shows getting cancelled.

Conclusion

I think the premise that the FED created the poker bubble is flawed in almost every way possible. Something can be temporarily popular without being a bubble, the popularity of poker continued far after the FED increased interest rates, and the regulatory changes provide a more logical framework for explaining the decline in popularity. And if Austrian economics explain why we have had a poker bubble, can it also explain why we didn’t have a table tennis bubble? And how does it explain the “pogs” bubble in the 90s?

The popularity of poker and low interest rates are in my opinion just an accidental weak correlation, not an explanation. And you can certainly not explain developments in the brick and mortar poker business while ignoring online poker or regulatory changes.

The Furlong Fund stirring things up at Solitron

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Solitron announced a few months ago that it intends to hold a shareholder meeting, for the first time in years, this summer after the release of the annual results. The Furlong Fund isn’t going to wait for this, and is going to court to compel the company to hold a meeting as soon as possible. Good news, especially since the fund is pushing for some big (and in my opinion positive) changes with regards to the company’s board and poison pill:

On February 5, 2013, the Plaintiff submitted an amended Rule 14a-8 proposal and an Amended Stockholder Notice providing notice that Plaintiff intends to (1) nominate two directors; (2) implement a majority voting standard for uncontested direct elections; (3) present nonbinding resolution to redeem its poison pill; (4) amend the by-laws to require a shareholder vote before adopting or amending a rights plan; (5) repeal all by-laws enacted since January 14, 2013 which were not filed with the SEC and are inconsistent with any of the proposal approved by the shareholders at the next annual meeting; (6) amend the bylaws to grant shareholder access to the Company’s proxy ballot for future elections; (7) amend the bylaws, providing Solitron shareholders the option to fill newly created board seats between annual meetings by vote of the shareholders as opposed to appointment by the board and clarifying the right of shareholders at an annual meeting to elect directors to newly created board seats where those seats are up for election; (8) expand the size of the board from three (3) to six (6) board members; and (9) if the board is expanded to six (6) or the number of seats otherwise increased, to nominate an additional three (3) directors

Check out this post at “Ragnar Is A Pirate” for the full (legal) details.

Disclosure

Long Solitron

WSP Holdings going private arbitrage

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WSP Holdings (ticker: WH) is a Chinese manufacturer of tubing and drill pipes used in the oil and gas industry. Talks about a possible going private transaction have been ongoing since the end of 2011 when the company received a non-binding proposal to go private at $3.00 per share (adjusted for a reverse split). Since then there has been little news from the company, until today when it issued a press release that a definitive merger agreement has been reached and that it’s going to pay $3.20 per ADS. The company has not yet filed the form SC 13E3 so not all details are known yet, but I’m assuming that this is effectively $3.15 since there is probably a $0.05 ADS cancellation fee.

I was already long WH before the definitive merger agreement was reached, but I actually increased my position today since the risk of the deal not going through is now minimal and the spread between the current market price and the buyout price is significant. At the time of this writing the latest trade was at $2.85, implying a possible 10.5% return in probably 3/4 months time since the deal is expected to close in the second quarter.

I’m going to keep this write-up short, but to cover the main points:

  • CEO owns 51% of the outstanding shares and UMW owns 22.5%. They will both retain their equity interest in the company, and they have combined enough voting power to approve the going private transaction.
  • They have financing to fund the merger consideration
  • The financial health of the company is a bit sketchy: they have a lot of debt and actually breached debt covenants in the past. Business was bad because of US anti-dumping duties on Chinese OCTG suppliers in 2009. They have responded by building a facility in Thailand.

I don’t think that there is a significant risk that the deal is going to fall through at this point in time. The insiders know what they are buying, and if the financial condition of the company would have been a problem they would have exited the going private transaction a long time ago. Financing and shareholder approval also doesn’t seem to be a problem, so getting paid more than 10% while waiting for the transaction to close is in my opinion a very generous risk compensation.

Disclosure

Long WSP Holdings

A closer look at my current portfolio

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As a reader of this blog you probably know most of the stocks that I own since I’m keeping track of my purchases and sells on the portfolio page. But just a list of stocks doesn’t tell the whole story. How big the various positions are in absolute and relative terms is for example very important from the portfolio perspective, and just looking at a list it’s for example hard to see how the companies are distributed geographically or how they are valued on average. So lets start with an overview of the positions of my portfolio:

Alpha Vulture portfolio overview by positions size

Almost everything you see in this list is something that I have discussed previously on this blog. I’m quite content with the number of positions and their sizing. If I would start from scratch I would probably size some of the positions lower down on the list slightly different, but don’t think it matters a whole lot if a position is 4 or 5 percent of the total portfolio. Not a single one is so big that I would lose a night sleep if it would go to zero, but I certainly don’t think that’s likely for the bigger positions. Berkshire Hathaway is a diversified conglomerate with a solid balance sheet that would probably do relative well if shit hits the fan. Asta Funding has most of the balance sheet in cash while Alternative Asset Opportunities should have returns that are uncorrelated to the market. Hard to see how these could turn out disastrously. The first real risky positions are, in my mind, Conduril and Salem Communications. They have a weaker balance sheet, but Conduril is nicely profitable while Salem Communications is deleveraging and generating tons of cash flow.

The amount of cash that I’m holding is probably also a good subject to talk about. Compared to some value investors the amount of cash in my portfolio is low, and this is actually a highish level for me. I just happen to have some cash because a few special situations recently liquidated, but it’s my goal to be more or less fully invested as long as I’m able to find undervalued companies or attractive special situations.

Having said that: if you would look at my portfolio on a look-through basis I do have a lot of cash, but it’s at the level of the individual companies. ASFI, Rella, Solitron, Deswell, OBIC and ALJ are all companies with roughly their market cap in net cash, and some of the other companies on the list also have a solid liquidity position. It’s a bit too much work to calculate it exactly, but I estimate that effectively ~35% of my portfolio is in cash or cash like securities. My hypothesis is that as a result my portfolio would do relative well in a bear market, especially since I also have a few small short positions that reduce my market exposure.

Closely related to the number of positions and their sizing is the diversification of the portfolio, so time for the second graph: an estimate on how the various businesses are located throughout the world.

Alpha Vulture portfolio exposure by region

Given the fact that my two biggest positions are located in the US it’s not a big surprise that I have a lot of exposure there. I don’t really care how my exposure is exactly distributed around the world, but I don’t want to be too concentrated in one single region. I would prefer to own a bit less in the US and probably a bit more in Europe, so if the opportunity arises I wouldn’t mind swapping a position in the US for a new position in Europe. I also have to note that the above diagram is a crude representation of reality. It doesn’t account for companies exporting to, or being active in, other countries. Allan International gets for example a lot of revenue from Europe, but since the manufacturing facilities are in China I decided to put it in the China bucket.

I could create a similar diagram with regards to my exposure to various industries, but don’t think that’s really useful since the overlap in sectors is minimal in the portfolio. This is unless you go to a very broad classification and put for example Berkshire Hathaway and Asta Funding both in the financials category. While that’s technically correct I don’t think that would provide any useful information since both businesses are totally different. It’s not very different from putting Microsoft and your pop-and-mum grocery in the same category.

The biggest overlap is in the (life) insurance sector. AIG and Delta Lloyd are both active in the life insurance business and Berkshire probably does have some correlated exposure as well somewhere in their insurance and reinsurance businesses. Given the fact that AIG and Delta Lloyd are both relative small positions and Berkshire is also doing a lot of other things I’m comfortable with my exposure. But it’s unlikely I would invest in a new insurance company without exiting another.

To finish this post, some questions for my readers:

  1. How do you perceive the riskiness and the diversification of the portfolio?
  2. Did you find this post about my portfolio composition interesting?
  3. Anything else you want to know about my portfolio?

Disclosure

Obviously long everything discussed