Why I Avoid Commodities

I’ve been biased against commodity producers and for the most part have stuck to my bias. They have great growth and returns on capital in a cyclical upswing, but they
tend to peak before you expect. They are capital-intensive and lack pricing power. They are prone to competition, overcapacity, and overleverage. Plus cost overruns is frequent and so does funding uncertainty.

Occasionally, I’ve been seduced by a commodities story that appears to be either so
cheap or so unique that it can’t lose. For a while, it doesn’t. Inevitably, though, demand and pricing fall apart quicker than you expect and a stock price drop of 50% or more leaves me wondering I have ever strayed from our discipline to avoid commodity stocks.

I got really lucky twice. Once with Cliff Natural Resources and Tronox. I got in Cliff at $19 and got out at $25. Then iron ore prices collapsed and so did Cliff. It went down to a $3 a one point. With Tronox, I actually wrote a piece in Seeking Alpha recommending the buy. It turned out to be my worst recommendation on Seeking Alpha. My thesis was grounded on the fact that the demand for titanium dioxide
would rise and the glut of TiO2 would disappear. I loss confidence in my thesis and I got out between $21 and $26. Then Tronox collapsed to a few dollars. Since Tronox has rebounded to $14 and Cliff is at $6. The rollercoaster stock price action points out how little control commodity producers (and their shareholders) often have over their destinies.

This does not mean I am good at investing in commodity stocks and I should avoid them. I got out because I was a chicken, not because I knew that commodity prices would collapse. I was just lucky and my analysis was weak.

“You can’t con people…” – Trump

“You can’t con people, at least not for long. You can create excitement, you can do wonderful promotion and get all kinds of press, and you can throw in a little hyperbole. But if you don’t deliver the goods, people will eventually catch on.”- Trump wrote in his book, The Art of the Deal.

I am Pilgrim

This is my review of I am Pilgrim by Terry Hayes. This is an excellent book and I highly recommended it. My wife also thinks it’s excellent and she’s the one who recommended it to me. We don’t have the same taste of books, so it’s a surprise, or a rare event I would say, that we both appreciate the same book. If you are looking for some summer reading, you won’t be disappointed with this book.

If you read the back of the dust jacket, you might think that the book is all over the place and it’s not for you. And in a sense, it is all over the place. But it was done on purpose. Usually that’s a recipe for disaster, except in this case. All the crazy events eventually ties up. The story takes you a on a wild ride. There’s two part to the story, which is the reason behind why this is a big book. The book combines both a murder mystery and a terrorist plot to unleash a cataclysm on America. The book takes into a series of strange events. The main character, “Pilgrim”, is a great character. He’s smart and insightful.

There’s a sequel to the book coming out next year, The Year of the Locust, which is coming out sometime next year. I also read some stuff about a movie studio picking the rights to the book/character. So this should be interesting but I don’t know how this story will hold up on the big screen. However Hollywood did make an excellent movie about a baseball stat book, Michael Lewis’ Moneyball. So I’m sure they can figure out something. Terry Hayes is a Hollywood guy and his background is in movie scripts, so maybe he can work his magic. And congrats to Mr. Hayes on his first novel. It must be very different from going to movie scripts to a very long novel.

A Negotiation Win

Here’s an interesting quote from Sam Zell’s book, Am I Being Too Subtle? Straight Talk From a Business Rebel:

My definition of a “win” is not binary. It is not a zero-sum game. Negotiation that leads to a winner and a loser rarely leads to a successful transaction or another one down the road. That’s how it’s been  throughout my business career. Sometimes my team argues with me-they can’t believe we’re leaving money on the table. But I want to create an environment where everyone wants to keep playing. (p. 220)

Zell knew that by making other side happy early on he could get more deals in the future. Everybody stays in the game and everybody keeps playing. Great mottos for anyone in business or investing.

How Stupid Decisions Are Made and Rubber Ducks

WALLY SANTANA / AP

Your assumption that a chunk of your hard earned money that goes to the government is wasted does not go unfunded. For the celebration of the 150th anniversary of Canada, the Ontarian government is spending $120,000 on a giant inflatable rubber ducky. This is one of many cases where you wonder who makes these decisions? How does this happen?  We will never know in this case but having worked for a large organization in the past I have insights on how stupid decisions happen. It’s easy to blame the Premier/leader for such stupid waste but with so many levels of management and bureaucrats, I think good ideas are lost in the process and are affected by the result of group think. Here’s my take on the rubber ducky fiasco.

First, a comity probably set a budget for the festivities. With the help of a HR firm, they hired a bunch of people (like Bill and Randy) with MBAs to come up with ideas how to spend the money. Lacking ideas, Bill and Randy hires an external consulting firm to come up with something exiting. The very expensive per hour +fees consulting firm gladly accepts the task. The consulting firm runs a bunch of focus groups, do some “market research”, and other gimmicks to fill up their pricey report. Bill and Randy then send the report to the comity for approval. The comity, looking for ways to justify is existence, hires another consulting firm to have a 2nd opinion. The consulting firm suggests some changes to justify their fees. The comity submits the amended report to some board to get it approve. The board then sends the report to some regulatory agency with their own army of bureaucrats to make sure that none of the ideas were too over the top because you wouldn’t want a scandal on the 150th anniversary of Canada. This takes a lot of time and the report is sent back requesting some changes. By that time, the original people that were hired, Bill and Randy, got transferred to a different department and were replaced by new hire Linda and Hank (both MBAs). Hank and Linda goes back to the drawing board to come with new refreshing ways to celebrate Canada’s 150th. During the process, Hank is off on paternity leave for a year and Linda is unfortunately on medical leave. Again with the help of an external HR firm, the comity manages to temporarily replace Hank and Linda with Tim and Gus (MBAs) at the last minute. With time running out and knowing that he has no job prospect following this project, Gus decides to smoke weed with his buddy Bobby (Bob) that has a rubber ducky company. Bob makes a joke about a giant rubber ducky and that’s when Gus decides to use it as his idea to celebrate Canada. Gus suggests the giant rubber duck idea to the comity and plugs in his buddy’s rubber ducky company. The board submits the idea for approval to a few agencies like nature, ethics, marketing, First Nation, Second Nation etc… And finally Bob gets the contract because he’s the only one that submitted a bid since nobody else has a giant rubber ducky in their inventory. Gus is then poached by Bob’s rubber ducky company and becomes an official lobbyist. Happy 150th Canada Day!

I think that what happened. I think that’s how a lot of serious decisions are made. I have seen some of the stuff above happened when I worked in the private sector. I don’t mind giant rubber ducks. I just wish it was private money that funds it. Anyway if the rubber ducky ever comes near my home I will bring my daughter to see it so I can tangibly show her why her school is broke.

As for what’s to come next, since the giant rubber ducky has no particular meaning, it could be used for a bunch of other government celebrations. With about 200 countries around the world and a scarcity of giant rubber ducks, this could lead to situations of over bidding which would result into a gold mine for Bob since governments are not in the business of saving money any time soon.

Why Nobody Likes Politicians

Fairfax Lollapalooza

I just got back from a two week trip to Toronto. The first week was spent exploring Toronto with my family. The second week of the trip was spent attending various investment events and I want to use this newsletter to share my insights. The events are based around the Fairfax Financial Annual General Meeting (AGM). Over time Fairfax has developed a following of investors and numerous events have spun-off from the AGM. There are conferences, stock picking competitions, dinners and plenty of opportunities for new investment ideas. When you spend most of your time reading company filing and looking at financial statements, these events are a welcome change. But first here are some thoughts on Toronto.

Toronto 2.0

I took some time to visit my brother, Torontonian Hugh Langis, co-founder and co-owner of Half Hunter (design studio) and The Station (best co-working office space in Toronto), which I shamelessly just plug in. By the time of my visit it was already spring time in Toronto and it was just warm enough to walk around. There’s only so much you can do with a two and a half year old but if you get the chance, the Royal Ontario Museum is a good spot to take your family. There are plenty of dinosaur skeletons among other artifacts. I have to say that the city of Toronto got a lot better over the last ten years. When I first stepped in the city in 2002, I wasn’t that impress. Toronto is often described as “la ville reine” (the Queen City). When your nickname is linked to Queen Victoria’s reign, entertaining is not what comes to mind. “Banks and malls” is how I had described Toronto. But that has changed. Millennials and hipsters took over the suits and royalists and transformed the city for a better place. Now Toronto is populated with cool indie coffee shops, trendy restaurants and great pubs for happy hour. The places are jammed packed in the middle of the day. I’m not sure if anybody works in Toronto. While it’s fun to see the city alive, I never fully understood how they manage to pay rent considering the booming prices of real estate (more on that later). Toronto is certainly closing the gap with Montreal. Today Toronto can say they have decent smoked meat, poutine, and bagels, all trademarks of Montreal. I also found Toronto to be cleaner than Montreal. Right now, Montreal is going through a rough time with all the constructions and its orange cones scenery.  Corruption and a lack of leadership have set the city behind but Montreal will be vastly improved in five years once the mess is cleaned up.  When I was in Toronto there was a pulse in the city. The Maple Leafs was in the playoffs (that’s a very rare thing) so were the Raptors. It was also the beginning of the MLB season and the Blue Jays were playing in Toronto. The city felt alive!

Toronto Real Estate

The Toronto real estate situation was the topic du jour while I was in Toronto. Toronto stole the crown from Vancouver for the most ridiculous real estate prices in the nation, and maybe in the world.  Owners and sellers are a very happy camp and while potential buyers are very frustrated. Toronto real estate has been considered expensive for at least the last seven years. Now the prices just shot up 33% year over year. What was considered “bubble price” a year ago now looked like a steal. Why did prices shot up 33% in one year? No reason. The fundamentals didn’t change. The economy didn’t boom. Population is modestly growing. Speculation is responsible for the booming prices. Sometimes higher prices are responsible for higher prices. There’s a pure disconnect between price and value. Housing basically should only rise by the extent of inflation, which is very low, and the extent of the productivity of the country, which in Canada is also very low. Real estate agents in Toronto like to cite the “strong demand” for the rise in price. But this runs against simple economic theory. Demand doesn’t increase the more you increase prices. In other words, the more expensive the real estate gets, the less demand there should be, not more. Need more signs that speculation is behind the rise in prices? A month ago Toronto held its real estate conference. The place was crowded with subprime lenders, third party lenders, and exhibits on how to get a second mortgage on your house.  That’s should be enough red flags.

Continue reading “Fairfax Lollapalooza”

What’s Going on with Retail (and it’s not the weather)

Interesting comments on page 15 from Steven Roth, the Chairman’s letter of real estate investment trust Vornado Realty. Here are his comments:

Disruption in retail is the topic du jour, the eye of the storm so to speak (both retail tenants’ and retail landlords’ stocks have been battered), so it is appropriate that we get into a fulsome discussion of retail this year.

In the be-careful-what-you-wish-for department, we made the prescient call four years ago that retail was in secular decline and acted on that by selling our malls,(17) spinning our strips into Urban Edge Properties, while retaining and even growing our flagship street retail in Manhattan.

So what’s wrong with retail:(18)
·
The U.S. is grossly over-stored. ICSC publishes 24 square feet of shopping center space per capita.(19)
·
The struggles and failure (or near failure) of many household names in the anchor and chain store business.
·
Traffic in shopping centers, while difficult to measure, is clearly declining and has been for years and so that makes a trend.
·
Shopping preferences and how we shop have changed, especially among millennials.
·
Most brands have become ubiquitous and, therefore, less differentiated and important.
·
Price and on sale is the only strategy which seems to work.
·
And then, of course, there is Amazon and the Internet.

I do not believe we can grow our way out of this mess. I believe the only fix for brick and mortar retailing is rightsizing by the closing and evaporation of, you pick the number, 10%, 20%, 30% of the weakest space.  This very painful process will surely take more than five years.  It will also create enormous opportunity for those with the capital and management platforms to feed on the carnage.

So if we were so prescient as to predict the secular decline in retail, and sell our malls, and spin our strips, why did we keep our Manhattan flagship street retail?  We believe Upper Fifth Avenue is enduring (read forever).  We believe Times Square is enduring and unique. We believe in the handful of world cities.  And, we believe the quality and scale of our Manhattan flagship portfolio is unique, irreplaceable and commands a premium.

Of course, even we are not immune.  It’s only to be expected when a tenant’s basic business model is being threatened that they hunker down rather than step up. For flagship retail (and for A+ malls), this is a pause, a cyclical bump. For everybody else, it is secular disruption.  Interestingly, several fast fashion retailers have told me that their 10-year plan is for smaller fleets (fewer stores), but with more and larger flagships.  That strategy makes eminent sense to me.

_______________
17
We sold the malls (into a very strong market) and spun off the strips in half measure anticipating secular decline (note the current softness in retail) and recognizing that with only a handful of malls, we were in no man’s land, and in half measure to de-conglomerate i.e., there is no real benefit in having $50 million shopping centers in New Jersey, no matter how great they may be, together with million square foot office towers in Manhattan.  I believe the decision to exit the mall business will look better and better as each year goes by.
18
Retailing stinks, right? Well, maybe not… note that the richest people in Europe are all retailers, the founders of: Zara, H&M, Ikea, LVMH and that the richest in the US is a retailer, if you aggregate the wealth of Sam Walton’s heirs.
19
The next highest country is Canada with 17 square feet per capita, Norway is next with 10 square feet, all the mature European countries are in single digits.
Further, the 24 per square foot number is not credible. There are 17.7 billion square feet of total retail establishments (both in and out of shopping centers) versus a population of 323 million or a startling 54.9 square feet per capita.  Granted this larger number now includes car dealerships and the like, but it also includes all the freestanding Walmarts, Costcos, etc.

A Primer on Mortgage-Backed Securities

This sums it up:

Major Causes of Failed Acquisitions and How to Avoid Them

This sheet of paper was provided at of the Ben Graham Centre’s 2017 Value Investing Conference that I attended last week. Tony Fell, the retired Chairman of RBC Capital Markets & Former CEO, used it during his speech. He was with RBC Capital Markets and its predecessor for 48 years. We often hear and see that M&A is not as successful as it should. We hear that’s it’s the culture or this or that for the main cause of failure. The list below is brief and useful. Here are the major causes of failed acquisitions and how to avoid them. I particularly like point #3 and #12.

  1. Start off by reminding yourself that fully 2/3 of acquisitions do not work out and actually destroy shareholder value. The odds are two-thirds stacked against you from the get go.
  2. Always remember – the best deal you do in your career is often the one you don’t do.
  3. Always remember the buyer needs a thousand eyes – the seller only needs one.
  4. Beware so-called major transformational mergers or acquisitions – they usually blow up and many have been catastrophic.
  5. In any takeover usually best to be the seller and get a good premium.
  6. Synergies are often significantly over-estimated and take longer to achieve than forecast.
  7. Beware of the auction process – and don’t bid against yourself
  8. Hold your ego in check, don’t get caught up in the euphoria of an acquisition and pay too much. When you pay too much, your returns may be terrible and your may be faced with substantial write-offs.
  9. Beware poor, or incomplete acquisition due diligence. Nothing worse than major operational or financial surprises after you buy a company.
  10. Calculate earnings accretion or dilution based on constant leverage ratio. Accretion due to increased leverage is not accretion.
  11. Beware of potential clashes in corporate culture of two merging companies.
  12. Remember that the vision of the acquisition is great but execution is where it’s at. It’s one thing to acquire a company, it’s quite another to integrate it into your own business and run it. Vision without execution is hallucination.
  13. No acquisition is make or break. There is always another train.
  14. On any acquisition don’t increase leverage beyond a very prudent level. Finance with equity.
  15. Beware international acquisitions. Foreign markets are often more competitive than Canadian markets with lower margins. Don’t expand beyond your ability to manage tightly.
  16. Notwithstanding the above perhaps 10%-20% of acquisitions are outstanding successes.
  17. Good Luck.

Major Causes of Failed Acquisitions And How To Avoid Them