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OZ GOLD RUSH; RNC MINERALS ($RNX.TO, $RNKLF) – LARGEST GOLD NUGGET EVER MINED

I have written on miners several times in the past for ibankcoin from the peanut gallery, but from inception no event has been as profound, so glorious, as the “Fathers Day Vein” find by Canada’s Royal Nickel Corp., dba RNC Minerals (RNX.TO, RNKLF otc/pink sheets) at their 100% owned (via sub lease) “Beta Hunt” mine in Western Australia, at Kambalda, 560km (320 miles) from Perth.

RNC Mineral have mined specimen rocks, from a single cut, with visible gold this month from their Beta Hunt mine grading in excess of 2200 g (68.4 oz.)/t (no typo). The largest specimen rock at 95kg. had 69kg. of total gold (quartz making up the bulk of the rest) and required no further processing, being sent directly to the Perth Mint. The scale of this discovery should not be discounted. The nugget sample is the 2nd largest ever mined by man and the grouping  of high grade nuggets ranks in the top 10 ever found (107 billion humans have lived on Earth since existence, 7 billion currently present and accounted for). Profile picture with the larger “Fathers Day Vein” specimen rocks features from left to right; SLM Geologist, Lachlan Kenna, Air-leg miner credited with the find Henry Dole, Beta Hunt mine foreman Warren Edwards and Snr. Geologist Zaf Thanos. Happy lads all.

Strike length continues to be refined (2x original now) and an addition 2 km of potential lies ahead. The gold find, from a space basically the size of a large living room, is 24,000 ounces (worth US$29mm, C$38mm). This leads all to think house, football field, airport runway, Newark, NJ., hence the buzz. Given the richness of the find, margins have been estimated at 90%. The specimen stones will likely be sold at auction for a premium as high as 30% to the gold content (15% offered already by yet unnamed museums). The interweb is loaded with coverage on the story as one might expect. In the age of social media issues of continuous disclosure are sure to arise, but the team at RNC Minerals seem up to the task at hand.

Press release related to the “Fathers Day Vein” discovery by RNC Minerals at their Beta Hunt mine is available on their website; http://www.rncminerals.com/2018-09-20-Fathers-Day-Vein-Yields-24-000-Ounces-of-Gold-Worth-38-million There is an informative Webcast of their 11-Sept.-2018 press release which is worthwhile also. For further information: Rob Buchanan, Director, Investor Relations, T: (416) 363-0649, www.rncminerals.com

 

Note: The other visible metal in the sample is quartz (fly is for scale I assume).

Mining has become expensive, the easy stuff has been done …so we thought. Many jurisdictions are difficult to operate in, subject to government overreach and/or outright nationalization. Spectacular gold grades are largely a thing of the past, trending to 2-3 g/t (5g/t was thought to be economically viable at historic gold prices). . Pretium, $PVG, another Canadian miner, was putting up (modern day) staggering numbers of 14.1 g/t from their Brucejack mine in British Columbia, Canada. Recent Milli Vanilli allegations re: sampling abnormalities have compressed PVG’s market cap aspirations, but with a market cap of $1.6bln Pretium is still a full 10x bigger than lowly junior miner RNC Minerals.

https://ibankcoin.com/firehorsecaper/2016/10/19/pvg-pretium-resources-theres-gold-in-them-thar-hills/#sthash.NM4hjYZG.dpbs

 

Many of the biggest finds (individual gold nuggets, of all time) have been Australia domiciled:

Top left in the graphic, Welcome Stranger (mined In The Year Of Our Lord 1869) from Australia netted 2520 troy ounces of gold. The biggest nugget of the “Father Day Vein” netted 2440 ounces for a very close 2nd place, but now takes the record as the largest nugget still in existence.

Largest nuggets still existing (others processed for precious coins and deliverable bullion by various mints):

1.) Canaan nugget, Brazil 1983, 60.8kg. (1682 troy ounces).

2.) The Great Triangle, Russia 1842, 36.2kg. gold assay 91% (32.94 kg gold). (Father’s Day Vein 82.5% 95 kg. gross, 78.4 kg gold).

3.) Hand of Faith, Australia 1980, 27.66kg. (largest ever found via metal detector …. a good day), currently housed at the Golden Nugget in Las Vegas, NV, USA.

4.) Normandy nugget, Australia 1990, 25.5kg. (820 oz. gold … 80-90% purity).

5.) The Kum Tow (aka Kum Fow, Rum Ton), Australia 1871, 22.5kg.

6.) Ironstone, “Crown Jewel”, 1992, California, USA 16.4kg.

RNC Valuation:

As with many mining juniors, RNC has has its ups and downs, on balance, more downs of late. As you might expect from their name, Royal Nickel Corp. (dba RNC Minerals) is primarily a nickel miner. Their key asset is their 28% stake (JV with Waterton) in the Dumont Nickel-Cobalt Project in Quebec, Canada. The project contains the world’s biggest reserve of both cobalt and nickel (demand coming largely from the growing electrical vehicle market). The value of Dumont alone was enough to justify the C$0.44 (US$117mm market cap) price once you take insolvency off the table, which is what the Beta Hunt gold find has done. Money was tight and RNC was in the midst of selling “non core” Beta Hunt to fund their portion of the development plan at Dumont (C$1bln total cost). Dumont has a mine life of 33 years and 1.18 billion tonne reserve (proven & probable), containing 3.15mm tonnes of nickel and 126k tonnes of cobalt. The Father Day Vein find of 24,000 oz. of gold at the working Beta Hunt mine in Oz has clearly taken sale off the table (potential suitor likely steamed at the timing). Assuming the current valuation is largely for Dumont (Ni-Co), the Beta Hunt gold call option is hard to value until further exploration work is done to define the potential scope. What we do know is 12mm ounces of gold have come out of the region of which Beta Hunt is a part of. RNC Minerals are the first to explore the Lunnon Basalt at this depth (500 meters), level #15 (of 6 levels total being mined). Gold Fields Limited have rights to the first 200m as I understand it, with RNC mining below that depth threshold.

Eric Sprott, a self-made Canadian billionaire likes the RNC Mineral story, a lot. This week in a regulatory filing Mr. Sprott announced he had purchased 561,000 shares of $RNX.TO on the open market at an average price of C$0.4284, taking his ownership % > 10%. The bulk of Eric’s holding are from a 2016 bough deal financing which came with warrants (9.265mm exercised this week at C$0.43). Current shareholding 40.2mm shares of common. The current float is 390.3mm shares (fully diluted 477mm). Eric does a weekly for Sprott Money and has never seen anything like the specimen stones mined at Beta Hunt.

The majors will be all over developments at Beta Hunt. There has not been a find of this magnitude in a long, long time. RNC Minerals owns 100% of Salt Lake Mining (SLM) who purchased Beta Hunt in 2013 for A$10mm, mining rights secured from Gold Fields Limited ($GFI).

RNX.TO shares went from lower left to upper right all day Friday (yesterday 21-Sept-2018) closing up 31.7% at C$0.56 on 27.99mm share volume. The US dollar RNKLF (oto, pink sheets) closed at $0.4389, up 30.9% on 2.29mm shares.

Conjecture on the potential share price is premature until further mining is undertaken by SLM at Beta Hunt. Any indication of repeat occurence or continuity of the current seam will be well received given the richness of the recent grades. The geography has shown itself to be condusive (gold in quartz touching sediment), but coarse gold finds (>10g/t) typically do not have the consistency of lower grade gold mines. SLM previously had a plan of mining 60,000 ounces of gold per annum from Beta Hunt. How much there Beta Hunt numbers go up will take time to discern, the good news is they will have the money to get on it with a much quicker timetable than their budget previously allowed (114 employees; mgmt, tech srv and operations). While a micro cap at present (<$300mm), this is not a low float stock with almost 400mm shares outstanding. Real movement will only come with real results, but anchor investor like Eric Sprott help to provide a floor pending further clarity. This is a story and a ticker to monitor. In Q4 2010 RNC Minerals stock traded at just over C$2.50, as a point of reference.

Mark Selby, President & CEO of RNC Minerals takes the floor at the Denver Gold Forum Monday next at 4:30pm and you can bet RNC and Beta Hunt will be the belle of the ball. I will be watching developments closely.

Safe trading.

Follow me on Twitter @firehorsecaper

Regards, Caleb Gibbons, CFA

USD/CAD 1.2912

Disclosure: Long RNX.TO from open 21-Sept-2018 at C$0.44. On position sizing, I have a rule of thumb that has served me well in terms of sleeping at night on idiosyncratic single name exposure; never invest more in a single stock that you would pay for a car. I bought 100,000 shares.

 

 

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DIGICEL: EM BONDS – TIME TO BUY?

Denis O’Brien, Ireland’s richest native ($4.3bln) is the 94% owner of Digicel Group. Digicel Group offers telecommunications (wireless, cable, and business services) media and entertainment services to 14 million subscribers in 32 markets, primarily in the Caribbean and Central America. Largest markets; Haiti (16% revenues), Jamaica (16%), Papua New Guinea (13%), Trinidad & Tobago (6%).

Digicel bonds have been the worst performing emerging market bonds of 2018, losing 30% of their value year-to-date.

Macroeconomic/FX Risks:

The strengthening US dollar had been a big factor and analysts expect the effect to be ongoing, lessening top line revenues by as much as $220mm and EBITDAR by approx. $100mm per annum. A full 95% of Digicel’s debt is US dollar denominated whereas 50% of revenues are either USD or from markets where the currency is pegged to the US dollar.

Bond information:

DLLTD 8.25% 9/30/2020 RegS. Issue size; $2bln. Maturity 9/30/2020 (2.05 years) sub 2 year duration. Net leverage 7.0x (up from 6.4x prior year). Recent price $69.76, current yield 11.83%, yield to maturity 39.33%. Fitch downgrade 8/24/2020 to B-, neg. outlook. It remains to be seen what the bond market reaction will be to Fitch’s downgrade of Friday past, but I suspect it will be muted. Bond CUSIP USG27631AD56.

Digicel Group Limited (DGL) debt, of which there is $3bln total outstanding is structurally subordinate to $3.7bln of debt held in 2 other Digicel entities, 2.3bln in senior unsecured Digicel Limited debt and $1.4bln in senior unsecured terms loans/revolver at DIFL (Digicel International Finance Limited).

Potential sources of refinancing:

The market is anxiously awaiting the game plan from Mr. O’Brien on the refinancing of the DLLTD 8.25%’s of 2020. The fact that the market is trading at the current level of distress (i.e. sub $70.00) may offer opportunities for restructuring Digicel. Given the large issue size of $2bln, a successful tender for the bonds at $80.00 could save Digicel $400mm. XTract Research recently released a report eluding to this possibility, but as I understand it no price indication has been proposed. One potential value catalyst noted in the XTract report (I have only seen an exerpt) is rolling in the assets of the currently unencumbered Digicel Pacific Limited entity.

-It is possible that $1.2-1.3bln of additional secured debt could be raised related Digicel entities.

-Denis O’Brien has eluded to the possibility of an equity infusion in the past. When Digicel was “rolling in clover” as they say, Mr. O’Brien took out $1.1bln in dividends from Digicel, the bulk ($950mm) in the form of a special dividend. This action (an equity infusion) would be in keeping with O’Brien’s plans to eventually IPO Digicel. Denis last attempted the IPO route in 3Q 2015, but it is doubtful he will try again before 2H2019 when leverage can be brought down to a more manageable level of 5.7x. Fitch and the other rating agencies note there is a lot to like in the competitive positioning of Digicel which operates largely in duopoly markets boasting a market share of 50% in many (not to mention 40% margins). What the rating agencies are more concerned with is the liquidity situation of the group with $158mm in cash/near cash versus an annual interest expense of $456mm, approaching 50% of EBITDA (Note: IF Digicel were a US company their interest expense would only be partially tax deductible as the 2017 Tax Cuts and Job Act caps/limits the tax deductibility of interest to 30% of EBITDA).

-Asset sales. Digicel recently effected a sale/lease back on their cell phone towers which helps at the margin, but with net proceeds < $100mm the effect is minimal in the grand scheme of things. Beyond the 450 towers covered by the sale/leaseback details have been scant of the other $400mm O’Brien has eluded to (i.e. $500mm total asset sale program).Perhaps more important is getting capex back to 14-15% of FCF from the recent highs of 21% due to heady network investments.

-Cost cutting. No further meaningful cuts are achievable as 25% of the group work force was retrenched in 2017.

Value comps: EV/EBITDA; C&W (bought Liberty) 11.2x, Columbia (bought) 9.6x, AT&T (T) 8.5x, American Mogul (AMX) 5.3x, Telefonica (TEF) 5.4x, T-Mobile (TMUS) 6.2x, Orange (ORAN) 5.6x = avg. 7.4X.

Conclusion:

The DLLTD 8.25%’s 2020 have traded as low as $62.90 in 2018. The minimum lot size for the bond issue profiled is $200k (par value), hence if one were to buy the bond at $70.00, the initial investment would be $140,000 (plus accrued interest of almost $7k), qualifying as a substantial investment for an account sized at $5mm (i.e. 3% of invested capital). Too much single name risk for me, $100k par value is more typical. JP Morgan’s EM bond ETF, ticker EMB would offer similar exposure for individual investors with more modest account size. The ETF has $13.6bln in AUM with a dividend yield of 4.62% and a ytd -5.13% return in 2018.

Digicel (B2, neg. outlook). A total return >35% is attractive, especially when compared with the paltry 7.7% yield on longer duration single B3, neg. outlook credits like TESLA (i.e. TSLA 5.3% August 2025 bonds last traded at $87.20 to yield 7.7%) which carry much higher interest rate risk (TSLA’s 5.8 year duration versus sub 2.0 year for Digicel). Tesla’s current EBITDA is -326.2mm (analysts estimate $3.2bln in EBITDA for 2019) hence a potential double headwind of EV subsidy cessation and loss of interest deductibility. Shorting TSLA is too expensive and foolhardy, but you don’t have to own it for certain.

Follow me on twitter @firehorsecaper

Safe trading. JCG

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AMERIZUELA: $FNMAS FANNIE MAE – ONLY ONE OUTCOME, RULE OF LAW MATTERS

While a number of “Mom and Pop” investors were also caught in the downdraft of Fannie Mae and Freddie Mac’s Conservatorship in September 2008 (10 year anniversary next year!), the largest current law suits appear to be from the hedge fund community at large. Fannie and Freddie had $36bln in preferred shares o/s when they were placed into Conservatorship, with community/regional banks the largest aggregate holder.

Bruce Berkowitz’s Fairholme Capital appears to be the most “all-in” with respect to position sizing with 35% of the fund’s capital deployed long Fannie and Freddie subordinated preferred shares. AUM for Fairholme is currently approximately $3bln (they were managing $19bln at their pinnacle), making this a 10 digit wager.

In Fairholme’s words:

“Fannie Mae and Freddie Mac. We believe that these two companies may be the most important financial institutions in the United States – perhaps the world – and directly support housing affordability and accessibility, including the uniquely American 30-year fixed-rate mortgage. They are a major reason why our country did not descend into a second Great Depression. Millions of American families depend on Fannie Mae and Freddie Mac to lower the costs and improve access to homeownership. In times of stress, these two have helped to ensure the continued functioning of the U.S. housing market. They have no substitutes. Fairholme’s investment in Fannie and Freddie demonstrates a commitment to ignore the crowd and invest in valuable, systemically important institutions – even those that are politically unpopular.”

Richard Perry’s Perry Capital (in wind down), is also long the prefs, exclusively.

Bill Ackman’s Pershing Square is much less committed, in terms of size of position at least (but still a sizeable swing at 9%), and has chosen to purchase the common shares of both Fannie and Freddie (although he has been rumoured to be selling common in favor of the prefs). Both GSE’s applied to be de-listed in 2010 from the NYSE and now trade over-the-counter on OTCQB, the “venture” stage marketplace for early stage companies that report to a US regulator.

The original government bailout of Fannie and Freddie was $187.5bln and they have now remitted in excess of $265bln back to the Treasury ($78bln more than the amount of the bailout). Fannie Mae accounted for $116.1bln of the $187.5bln and have repaid $159.9bln total to date (owned + $43.8bln surplus via net worth sweep).

The mechanics of the tithe were changed in August 2012 when the 3rd Amendment to the GSE Conservatorship  was passed (both GSE’s were paying a 10% dividend to the US Treasury on the Senior Preferred shares up until that point). The 3rd Amendment, as it became known, called for a “Net Worth Sweep” which is to be kept, in effect, for perpetuity. The golden geese have remained tagged since and the $ have been rolling in. Earnings for both GSE’s have been bolstered by an increase in guarantee fees as the fees on new mortgages exceeds the fees on those in the existing portfolio. Both have seen growth in their total guarantee portfolio, along with underlying mortgage origination and finally both have experienced lessening credit losses as their aggregate portfolio level credit metrics improve. An amazing turnaround story, were it not for the gold eggs being sent to corporate (aka Treasury) while they are still warm from being laid.

Fannie Mae had a profit of $12.31bln in 2016 as a point of reference. One potential fly in the ointment, in terms of reported earnings going forward, relates to deferred tax assets (DTAs). This is a bigger issue for Fannie than Freddie because of the relative size of their DTAs and the potential impact of Trump tax reform (corporate rate from 35% to 15% proposed, but many handicapping a final rate of 20%). Fannie Mae’s DTAs stand at $35.1bln and Freddie Mac at $18.7bln. Steve Eisman, who disclosed owning Fannie Mae prefs in smalls,  implied on TV this week that the DTAs could prove to be a catalyst for action, implying the US Treasury would be called upon to make the GSEs whole on the potential DTA value impairment due to the proposed Federal corporate tax cut. I may have misinterpreted Mr. Eisman’s call on this, but one thing is 100% for sure, the status quo is not sustainable. The US Treasury can ill afford to assume an additional 5-6tln of debt by nationalising the GSEs when the non revenue neutral programs on the table already get the USA to the mid 20’s (trillion) in Federal debt.

The lawsuits have not been going swimmingly for the hedge fund dominated plaintiffs to date. Shares of both GSEs have dropped >25% in the last 2 months months after an appeals court upheld a ruling against shareholders challenging the legality of the government’s Conservatorship. Shareholders continue to argue that the government’s net worth sweep of all GSE profits in perpetuity is unconstitutional.  An overturn of the perpetual full profit sweep is  the only viable alternative leading to a non zero-valuation for both the common shares and junior preferred shares of Fannie Mae and Freddie Mac. This is a binary, legal based outcome, hence not for the faint of heart. Ackman’s take, “We believe that Fannie and Freddie offer a compelling risk-reward as there are various scenarios which will generate a many-fold multiple from current levels. While a total loss is possible, we believe the probability of a total loss is relatively modest, and has become lower in the new political environment.”

Catalysts for a positive outcome:

1.) The U.S. Supreme Court overrule previous court decisions and overturn the net worth sweep.

2.) Trump and Treasury Secretary Steven Mnuchin recapitalize Fannie and Freddie, returning control to shareholders.

The 2nd scenario is the one that has boosted the stock since Trump’s win in November. FNMA and FMCC spiked as much as 250% (from $1.65 to $4.40) before settling in at the current $2.65 level (+50% from November).

Nobody is better suited to craft and execute GSE reform than Mnuchin, aka “The Loan Ranger”. Post Goldman, he purchased failed Pasadena, CA IndyMac,  doubled its capital base (via additional acquisitions) renamed it One West and sold it to CIT for a tidy profit.

https://cei.org/blog/mnuchin-must-bring-transparency-fannie-mae-and-freddie-mac

Mnuchin has publicly stated:

“[We have got to] get Fannie and Freddie out of government ownership. It makes no sense that these are owned by the government and have been controlled by the government for as long as they have. In many cases this displaces private lending in the mortgage markets and we need these entities that will be safe. So let me just be clear we’ll make sure that when they’re restructured they’re absolutely safe and they don’t get taken over again but [we have got to] get them out of government control.” (Footnote: Nov. 30, 2016)

“[…] it’s right up there in the top 10 list of things that we’re going to get done and we’ll get it done reasonably fast.” (Footnote: Nov. 30, 2016).

Mnunchin’s right hand man is Craig Phillips, a near 40 year Wall Street veteran (most recently at venerable Blackrock) but he ran the Mortgage Securities unit at Morgan Stanley in the lead up to the GFC (May 2006, about a year before the wick was lit on the MBS woes to follow).

With Housing Finance Reform a top 10 priority, in terms of timing this likely makes it 2018 business (prior to 2018 midterms). The Trump tantrum we saw in the markets yesterday provide a potential entry point for punters willing to take Mnuchin et al at their word. FNMAS, the most liquid Fannie subordinated pref traded off by 5.6% to $6.75 yesterday (17-May-2017). The 52-week range has been a wide $3-$11, reinforcing the speculative nature of the proposed foray. The low was close to 9/11/2016, the 8 year anniversary of the prefs going ex dividend on 9/11/2008. The Trump Bump sent the Fannie prefs prices skyward, from lower left to upper right as Gartman would put it, approaching $11, appropriately, on Valentine’s Day 2017. FNMAS now at $6.75 have since given back 38% from the February 2017 $11 high.

This is the appropriate time to ask, “What is the upside on an investment in Fannie Mae subordinated prefs (FNMAS)?”, given that the downside has been shown to be zero. Fannie Mae did not file for Ch. 11. It was placed into Conservatorship, along with Freddie Mac. The capital structure remains legally intact, under which the subordinated prefs rank behind the US Treasury senior prefs, but importantly ahead of the common (which is to be diluted by 80% …. the US Treasury mandated “deal” when placed into Conservatorship). Also worthy of note, at the time the GSEs were placed into Conservatorship all senior and subordinated debt of the GSEs was paid/matured at 100 cents on the $. Before the US Treasury prefs can be extinguished (legally) it highly likely the dividends on the subordinated prefs would have to be reinstated. There are 16 discrete series of Fannie Mae subordinated prefs, FNMAS just happens to be the most liquid. None of the prefs are cumulative (i.e. no legacy dividends are owned once they start to pay again). The coupon on FNMAS is Max (3 mth Libor +4.25%, 7.75%) with a par value of $25.00. Cessation of the net worth sweep would see FNMAS trade back to par ($25) in short order for a 3.7x return on invested capital. It will likely take Fannie Mae time to build a capital buffer once/IF the net worth sweep is nullified. The US Treasury, despite the windfall seen via the net worth sweep will likely mandate the timetable for their senior prefs to be repaid. FNMAS, on a dividend reinstatement would pay 7.75% until Libor gets to 3.495% (good things are happening if/when we get 3mth Libor back to a 3 handle, I assure you), at which point L+4.25% would become the MAX, hence the applicable coupon. Given how high the rate is versus current market rates, it stands to reason that steadfast FNMAS investors could well see the market price trade well above par. I like the potential payout on a positive outcome for FNMAS  (3.7-4.5X invested $) much better than FNMA common. FNMA common traded off 3.3% yesterday to $2.65 and with some analysts guessing on an equity value of $15 post net worth sweep that would get risk-seeking investors a 5.66x return on their money. The pick-up versus the subordinated prefs does not seem worth the substantial additional unknowns and the known capital structure inferiority in terms of priority of payments.

Mnuchin is scheduled to speak today on GSE Reform in front of the Senate Banking Committee. Nobody is holding out for 100% clarity, but in a land increasingly filled with mere whispers, a clear voice can go a long way in setting the future course for perhaps the #3 priority for the Trump administration (just behind healthcare and tax reform).

Follow me on twitter @firehorsecaper

JCG

Disclosure: Long FNMAS, 2% allocation @ $6.75.

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TESLA – $TSLA SHORTS: ASSAULT AND BATTERY

[Merrill Lynch: Thematic Investing – Global Future Mobility 17-Feb-2017:

Sustainable mobility: $7tn transport market facing disruption With over 1.2bn cars on the roads today, transport is a behemoth sector generating c.US$7tn in vehicle sales, supplies, and services. We believe that the sector is highly inefficient with 95% of cars parked at any one point, cars costing up to US$8.5k/year to own and operate, vehicles accounting for 1.2mn deaths p.a. and generating 23% of C02 emissions. Demographics (population to reach 9.7bn by 2050E) and urbanisation (70% living in cities by 2050E) will further strain existing infrastructure. The rising financial, social and environmental costs of transportation are unsustainable and demand a fundamental rethink of mobility. We see change catalysed by disruptive technologies and business models, rapidly evolving consumer preferences, and regulatory pressures. 4 game-changers: electric, autonomous, connected, and shared. In a world of exponential change as per Moore’s law, transport is a problem being solved at a tech pace. We believe that the convergent and mutually reinforcing trends of electrification, autonomous driving, the Internet of Cars (IoC) and the sharing economy will drive a fundamental shift from today’s car-centric travel to a platform-centric model whereby transport becomes a utility. Future Mobility – including an integrated, on demand electric fleet of autonomous taxis – can generate US$3.8tn of total positive impact in the next 10Y and lead to a “world of zeros”, including a 59% decline in vehicle demand, 87% fewer accidents, 54% fewer parking spots, and 85% lower emissions.]

Tesla Motors: One would think that Tesla could crack $300 a share on such ebullient projections (Tesla/Uber M&A perhaps). A lot of market cap has been added in a very short period of time, that is for certain. The last $100 move has been a blur with the stock up a full 24% year-to-date in 2017.  To grow in to the resultant current market cap Tesla has to be selling 1.7mm vehicles, at a profit, within 5 years (versus the 2.2mm currently produced and sold by mainline competitors such as BMW and Mercedes Benz).

As with all things “on the come”, much depends on the trajectory of China where 350,000 NEV’s (New Energy Vehicles) were delivered in 2016, 1.45% of the 24.3mm total vehicles delivered (up 15% yoy and accounting for 1 in 4 cars sold globally). EV’s account for 0.9% of sales in the USA and 1.3% in Europe in comparison. Chinese car producers accounted for 43% of global EV production (dominated by leading models from BAIC, Geely and BYD) and 46% of all plug-in sales globally. Tesla’s market share is 2% of NEVs in China (Japan is lower at est. 1.5%).  source: EV Volumes

Taking 59% of passenger vehicle demand out (ML 10yr #) should reduce emissions by at least that amount as some of the remaining internal combustion engine powered passenger vehicles are replaced with electric ones, but 85% seems like a high estimate to me. In China 31% of air pollution is attributed to vehicles, but heavy trucks as a sub category account for a full 90% of current total vehicle emissions. Despite Elon’s claims, electric transport trucks are not ready for prime time yet on the scale required to markedly change the emission numbers, the batteries required would be just too heavy (even before factoring the weight of the cargo) to stay within max payload limits (80,000 lbs.).

Estimated life to date Tesla sales in China are pegged at approx. 9,000 units (3000 were sold in 2015 versus an initial target of 10,000) and Japan at a very weak 2,000 (Japan’s EV subsidy is ¥950,000, or US$8,400), roughly equivalent to the US EV credit of US$7,500. As of mid 2016, Japan has more EV charging stations than gas stations. Tesla opened their 14th Supercharging station near Fukuoka in Kyushu earlier this month.

The fact that any credence is given to announcements like “opening” the Tesla market in India is laughable. Tata sells complete cars for less than the 55kWh battery cost projection on the new Model 3 Tesla. Ditto for Dubai on a relevance metric, Dubai will likely never hit 1mm in total car sales and 70% of current car sales are Japanese models.

I have previously written on the fact that EV subsidies are being curtailed in key global markets. The story does not end with EV subsidies either as Tesla has provided very generous residual buyback programs in key global markets like Hong Kong, which has very generous government incentives at the front end (fully detailed in the  legacy post below) putting a Tesla Model S pricing nearly on top of a gas powered Honda Civic and well below a Mercedes entry model. The 75% of purchase price buyback program after 24 months (low km) has been curtailed, but I fully expect lucky HK Tesla owners that have the “golden ticket” to exercise their put to Elon Musk. Factoring buybacks there is the potential to post net negative sales into China for Tesla in late 2017 to early 2018. Losing money on both the way out and on the way back into inventory as an exhibition (aka used) model will test the resolve of the hardiest Tesla bulls.

https://ibankcoin.com/firehorsecaper/2016/03/05/tesla-ev-subsidy-taper-tantrum-alert/

In the case of China, Federal NEV subsidies are expected to roll off by 20% in 2017 and regional subsidies by a more substantial 50-60%.

There has been a great deal of speculation about Elon Musk’s relationship with President Trump. Most recently, it seems like Elon is being relegated to dealing with VP Pense. Trump is very concerned with his image, it appears from afar, and it likely makes him uncomfortable that Tesla stock trajectory has left Elon with a paper fortune approaching treble his. Despite the fact that both Trump and Ryan have expressed a dislike for the current EV credit, Tesla stock has autonomously avoided the potholes and turned skyward like a SpaceEx rocket, seemingly never to re-enter Earth’s atmosphere. The EV credit may not be fully extinguished in the next budget, but it will likely be reduced from $7,500 which along with cheap $3/gallon gas might dissuade some of those Model 3 deposits from actually closing.

Tesla Energy: Even though the battery storage system revenue thus far in 2017 is estimated at a trickle like $15mm, Gigafactory 1 in California has launched and Musk is already projecting heady battery cost reduction of as much as 35% to under $125/kWh. With material costs estimated at $80/kWh this cost reduction is impressive. This result could allow the promised $35,000 Model 3 to be closer to a break even proposition for Tesla Inc. As for the sale of batteries to residential, business and utilities, all indications are that the business case is plausible, if not sound, and it is not unfathomable that revenues for 2018 approach $1bln, with the heavy lifting to come from the commercial and utility customers. Tesla’s PowerPack is scaleable to 1GW and will be an economically viable means to store relatively cheap mid-day produced power to be used when peak pricing is in effect later in the day (typically 5-9pm).

SolarCity clouds the analyst’s lens as to magnitude of the negative cash flow generation, but clearly not the sign (unprofitable; check, negative cash flow; check). The now combined Tesla entity carries a substantial $6bln in debt. Tesla has a market cap of $43.9bln, now greater than Nissan and honing in on fellow American Ford. Tesla has issued secondary equity on several occasions, the last being for $1.7bln in proceeds ($1.4bln + Greenshoe exercise) at $215 in May 2016. The stock rallied over 6.5% the week following the announcement, with the proceeds earmarked for Model 3 production with deliveries by the end of 2017 and bringing forward Tesla’s 500,000 vehicle unit build plan 2 years from 2020 to 2018 (as in next year, 2018). Patient investors should ready themselves for another secondary in 2017 (more debt on the heels of the SolarCity combination is not likely in my view), as fundraising has been an annual affair since 2012 and profitability can still not be seen with a Hubble telescope. Tesla’s market cap is so enormous at this juncture $3bln + might be in order to keep the transaction costs down. Tesla has 161mm shares outstanding and a float of 129mm shares. 26.6% of the float is held short, part of the reason for the recent pin action. Elon Musk owns over 20% of Tesla stock personally (all other insiders own 1.3% in aggregate, this is the Elon Musk show, have no doubt). The largest institutional investor is FMR LLC, better known as Fidelity Investments who own 13% of Tesla’s equity.

The Gini Coefficient at Tesla is off the charts, making it ripe for the UAW to eventually turn California plants. What potential gains Tesla might realize on battery cost via a well executed Tesla Energy launch can more than be given back through higher labor cost. Starting wages are $17/hr. in the Tesla plants (Toyota Motors Manufacturing average is US$39.50) on 12 hour shifts. Elon has been quoted as saying “changing the world is not a 9-5 job”. There is a reason that North American auto jobs have migrated from Canada to non-union southern USA and on to Mexico. If Tesla wants to retain its silicon valley nucleus it will have to eventually pay left coast wages, unionized or not.

Tesla’s book value per share is $17.03, hence it is trading nearly 16X book and 5x sales. Tesla does not own much in the way of proprietary technology. The Gigafactory is plug and play Panasonic technology. Elon once characterized patents as “a lottery ticket to a lawsuit”. The Japanese, by way of contrast, own 1/3 of the world’s o/s patents and it is the Japanese firms that dominate is areas such as ADAS (Advanced Driver Assistance Programs), electrification and emission control systems. Musk arguably has a narrow moat, with venerable global competitors breathing down Tesla’s neck across the broadening business lines of Tesla Inc. Rather than focussing on the pedestrian, largely outsourced means of propulsion (i.e. the battery) shareholders may have been better served in the long run (in the short run they have done just fine!) by focussing on the semiconductors and other high end technology components that are crammed into high-end, modern, connected EV’s (5x the amount of a “low end” vehicle, contributing over a 1/3 of the vehicles all-in cost).

Tesla Inc. has proven to be a difficult short, even for tenacious hedge funds, let alone lowly individual investors like moi. My TSLA T-acccount is close to flat on my 3rd short attempt (short @ $260 into “revenues”) with the 1st try profitable, 2nd a loser (1/3 of 1st trade profit) and the 3rd, so far, offside. Q4 2016 numbers are out after the close this Wednesday the 22nd with analysts expecting and adjusted loss of $0.51/share which would be a marked improvement on the loss of $0.87/share booked in Q3 2016. SolarCity is enough of a wild card to lead one to suspend opinion, but it is certainly not outside of the realm of possibility that the Q3 loss is further eclipsed.

Hopefully 3rd times a charm, but I have no plans to overstay with my short position and a stop loss at $300 is in place. JCG

Follow me on Twitter @firehorsecaper

Tesla short is the fellow on the right, to be clear.

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NEIMAN MARCUS – CONTRARIAN LUX RETAIL CREDIT PLAY

There are few things held in more deplore than retail at the moment. The list of retail equities that have blown up year to date is long, with Ralph Loren being only the latest to banzai skydive, and miss the chute. Luxury retail has not been immune, despite overall robust consumer spending.

While ibankcoin’s readership is largely focused on equity investment/speculation, hopefully my blogs posts have opened a few eyes to the bond opportunities that occasionally arise and merit both your attention and deep due diligence.

Enter the venerable luxury department franchise, privately held, Neiman Marcus (NMG), rated B3/B-. The speculative grade (Caa2/CCC) cash pay (I’ll explain shortly) NMG 8% 10/15/2021 (cusip 570254AA0) got rocked to trade < $60.00 last week for the first time. The bonds are currently wrapped around $61.00 for a yield to maturity (a quarter shy of 5 years) of > 21%.

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The capital structure is complex and the 8’s 21′ are as you might expect, rank near the bottom with a couple of classes of debt ranking ahead on them in terms of priority of payments. In the event of a tap out, the recovery rate would be expected to be low.

New York based independent credit research firm CreditSights moved to a buy from hold rating on the unsecured debt of NMG on 1-Feb-2017 on some “early signs of stabilization in the luxury good market, the benefit of a runway clear of maturities until 2020, and a decent prospect for neutral free cash flow generation over the next  year. While we view the prospects for recovery in the bonds as limited – given the significant contractual subordination to the ABL (Asset-based Loan) and large term loan – yield opportunities of approx. 20% offer an enticing return while the company attempts to get the story moving back in the right direction during 2017.”

The October 2020 term loan maturity is a big one at $2.9bln. There is $1.56bln of unsecured debt maturing 10/15/2021, including $960,000,000 of the cash pay 8’s 21′ and $600,000,000 of 8.75% 21′ PIK (Payment in Kind) notes.

Beyond poor operating results in terms of comps, margins and outlook, the market is reacting to the fact that NMG pulled plans for an IPO (filed August 2015, delayed and most recently pulled). The history of NMG is long, complex and storied. Founded in 1907 with a head office in Dallas, Texas, NMG has has varied ownership over the years. The first store outside of the Dallas/Fort Worth area was opened in 1957. NMG was publicly traded from June 1987 until May of 2005 when it was taken private via leveraged buy out (LBO) by Texas Pacific Group (TPG) and Warburg Pincus for $5bln. The exit was prolonged, but in October 2013 NMG was sold for $6bln to Canada Pension Plan Investment Board (CPPIB) and Ares Management, netting TPG and Warburg Pincus a $1bln gain versus purchase price. CPPIB & Ares went 50/50 on the venture contributing $1.6bln in equity ($2bln was “expected”) with the rest of the deal financed via the debt markets.

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Note: Trump’s signature. He is signing these executive orders Neiman Marcus? More recent renditions are even more similar.

 

Fast forward to today and approx. $900,000,000 of shareholders equity remains. The degree of leverage imparted in NMG on acquisition would make even Trump blush, and it has only intensified over the last 18 months. On the positive side, NMG is closely held by very savvy institutional investors that are used to taking the long view (CPPIB much longer in terms of liability matching). The next NMG IPO filing must be a successful one and beyond a century + long track record as a competent luxury retail operator, the elephant in the room is the immense debt burden approaching $5bln. NMG is well within their rights to suspend interest payments on the $600mm 8.75% 21′ PIK notes, a move that would save $52,500,000 per annum going forward. The signaling effect of such an election on the PIK notes would likely not be viewed as favorable though, and would likely take a potential IPO take-out off the table for the foreseeable future.

Owners with deep pockets is certainly a positive attribute. CPP and Ares have been equal partners to date, but there is nothing to dictate this has to be the case going forward. Ares would likely be somewhat reticent to add to a trade that has moved so far offside since late 2013. CPPIB, for their part, might look to creative ways to decrease leverage while operational efficiencies are given time to work through (cost cutting, reduced capex, further build-out of successful online offering “mytheresa”, etc.).

The current yield on the NMG 8% 10/15/2021 is 13.1%, if the bonds can be purchased for indicated $61.00 (+ accrued interest). The yield to maturity, as noted, is in excess of 20%. A plausible outcome would be for the current owners CPPIB/Ares to tender for the cash pay bonds, leaving the PIK bonds outstanding for debt servicing flexibility. Pure conjecture to estimate what percentage of the $960,000,000 of cash pay note holders might respond to a $70.00 tender offer, but given the prospects for a near term recovery from the dregs, I would expect at least a 50% take up rate would result. Deploying another $336,000,000 of equity under such a scenario would have the effect of extinguishing $480,000,000 par value of public debt, greatly improve the gearing numbers at NMG.

While not a pure “Red, White & Blue” lux retail play, given the Canadian connection, it merits further study for certain. Not for the widows and orphans due to outsized potential for losses , but in a measured dose Neiman Marcus debt may be worth a look.

Follow me on twitter; Caleb Gibbons @firehorsecaper

Disclosure; Not yet long, but vetting a 2.5-3.0% allocation to NMG 8’s 21′ in clips of 100k par value.

 

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EMERGING MARKETS – EQUAL WEIGHT IS 32%

I had the pleasure of hearing Singapore based Mark Mobius, Ph. D. (Economics, MIT) Executive Chairman, Templeton Emerging Markets Group keynote speech at the Asia PE-VC Summit 2016 held 30 September 2016, run by Deal Street Asia / mint asia.

http://www.dealstreetasia.com/stories/mark-mobius-54493/

Dr. Mobius was born August 17, 1936 (six years younger than Warren Buffett, born August 30, 1930). Nobody can rock a baby blue two piece suit and white shoes better than Mobius. Style and substance are rarely brought together in such a seamless fashion. At 80 year young, he is beyond sharper than a tack and offered a great deal of insight to a crowd, on average 45 year his junior.

Templeton has $28bln invested in 70 global EM markets at present, sprouting from a kernel of $100 million circa 1987. In South East Asia, the focus has been on PIPE deals (Private Investment in Public Equity). EM is up 1848% over the 1987-2016 period.

What keeps Mark up at night, other than travails of being 80, can best be summarized as the three i’s;

1.) Interest rates – Global Central Banks are the classic non profit maximizing counterparty and Mobius thinks they are destined to “make a mess” of it. Negative interest rates are far from a rational state. In terms of rational equity valuation, almost any p/e multiple can be justified in an environment of negative rates, 100 OK, 200 sure. Mark questions the mentality of said central bankers, overly influenced by academia,  economist and other charlatans (my term). Specifically called out was Ken Rogoff’s “Curse of Cash” as poppycock.

2.) Isolationism – Both with respect to trade and investments. A damaging trend. Little comment required on this point. Mobius grew up in Boston, Mass. but long ago relinquished his US passport and holds a German passport (his father was German and his mother was Puerto Rican) and a Singapore tax domicile.

3.) Internet – On-going game changer, especially in EM. Largely a mobile phenomenon.

China, still a monster growth story. It is all about the absolute numbers. Growth is slowing, but the absolute numbers are bigger every year (10% growth in 2010 is smaller than 7% in 2015 given the absolute size of the economy).

Biggest take away:

The people you are dealing with is the most important factor in investing, over the long haul. Having  a legal agreement is of course required, and governing law important, but typically if it gets to the stage of lawyers and the courts, the result is a big zero for all involved. Word to the wise, word to the wise indeed.

My current public market favorite instrument for EM exposure is WisdomTree’s Emerging Market High Dividend ETF, DEM, yielding 4.15%, ytd 2016 performnance +20%, AUM $1.6bln. No home country bias, as a global citizen. JCG

Follow me on twitter; Caleb Gibbons @firehorsecaper

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ESG : SOCIAL INVESTING = INVESTING

Even the Asian elephant in the room is endangered.

Over 80% of the market value in the S&P is attributable to intangible factors (environmental capital, sustainability governance and stakeholder relationships). Less than 20% is accounted for by physical and financial assets.

Global sustainable investing assets grew by 61% over the 2012-2104 period and now stand at $21.4 trillion. The domicile of these assets is telling; 99% are in the United States, Canada and Europe.

Environmental and social issues affect both valuation and financial performance. If your investment decisions focus only on financial disclosures, you will not be getting a complete picture of the drivers of value.

Global ethical principles have never been more important or, it appears, more wanting than in current times (i.e. VW, Phoney Express aka Well Fargo, global Trumpism, and global lawsuits imperiling not just returns but the very viability of global commerce beyond national borders).

Community manager education world tree concept with colorful abstract leaves and earth icon illustration. EPS10 vector file organized in layers for easy editing.

The UN supported Principles for Responsible Investment (PRI) ,a not-for-profit organization, held their 10th anniversary conference in Singapore last week (Sept. 6-8th) which I attended. No conference bag full of binders and junk mail at this conference, your 1 page agenda fold up into your name tag and all meals were vegetarian, a subtle but effective message. Forbes Magazine The conference domicile was not chosen by chance. Asia has been termed the cradle of disorder for a reason, it is home to 5 of the world’s 7 billion population and on metrics of social investing if the game has even started it is is the 1st inning. When a region has practices like dynamite fishing and farmers still clear land with a match much work lies ahead.

Chris Sanderson, Co-Founder of The Future Laboratory focussed largely on the sustainability of the capital markets. He characterized global citizens as being tired of austerity, wary of politicians and perhaps even more wary of brands. Backlash culture; http://shop.thefuturelaboratory.com/products/backlash-brands-report.

Elliott Harris, Head of the United Nations Environmental Program (UNEP) gave a rousing speech on environmental and social sustainability. The end game is that all investments will be social. Elliott introduced the concept of thick profit versus thin profit, a concept akin to quality, hard to define, but you know it when you see it.

Georg Kell of Arabesque Partners Arabesque spoke of  Generation S, a cross-section of all age groups working towards making the world a better place, one worthy of handing down to future generations. While ESG (environmental, social & governance) alpha may prove illusory, ESG smart beta appears to have legs.

Millennials were of course discussed with the most shocking realization being that the oldest ones (born 1990) are in their mid 30’s now! Generation D (Digital), whose only need or want in life is wifi and lithium, was out in full force, albeit well behaved and overall attentive. The 600 conference attendees were largely baby boomers, representing approx. 50% of global financial assets under management (AUM), signatories to the PRI whose mission states, “We believe that an economically efficient, sustainable global financial system is a necessity for long term value creation. Such a system will reward long-term, responsible investment and benefit the environment and society as a whole.” Clear, concise, devoid of the typically mumbo jumbo one gets when issues like climate change and the environment are normally tabled.

The session run by GS alum David Blood, Managing Partner at Generation Asset Management Generation Investment Management was excellent. Al Gore is the Chairman of Generation Investment Management. If Obama delays the election to allow Clinton to get her legs perhaps they could run as a Third Party choice? Could not lose with the ticket “Blood & Gore”. Both men can readily point out Aleppo on a map too. In any event, David’s sage words rang true to all in attendance. Finance and capitalism is not working for everybody was a key statement. The transition to a low carbon economy will clearly not be an easy one. A full 1/3 of aggregate world equity and fixed income market value lies in the cross hairs. We can do this the hard way or the easy way, but de-carbonization is a trend now moving under its own power. Mr. Blood noted that while the majority of global asset managers in attendance (120 signatories, 50% of global AUM) were managing to sustainability factors, those not present (i.e. non PRI Signatories) are largely American. The reasoning to date for USA firms reluctance is that becoming signatory could put them in breach of their fiduciary duty. We must collectively get the remaining 50% on board as priority #1.

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Investing for the long term. Short termism. A great panel on investing for the long term had some serious panel power. The headliner was Hiro Mizuno, CIO of Government Pension Investment Fund, Japan (GPIF), the world’s largest funded pension plan. GPIF manage their liabilities to a 100 year time frame. Their most recent result showed a loss of ¥5.3tln (US$5.2bln) for the current fiscal year through March 2016. The fund’s quarterly loss through June 30, 2016 was > ¥5tln (-3.88%). They run ¥130 trillion (US$1.27 trillion) leading Mizuno-san to characterize the latest qtly loss as peanuts. The joke was not well received, perhaps because it was so unexpected, leading Hiro to quip that perhaps there were Japanese pensioners in the audience. The fund increased their allocation to equities in recent years. Global equity investment totals US$600bln, 80% of which is allocated in a passive fashion and 20% ($120bln) of which is actively managed. All investment are mandated to external manager, counter to the global trend in the pension arena of in-sourcing. Fellow panelist Paul Smith, President & CEO at the CFA Institute noted that one advantage of being old is that “you see everything twice” with such decisions as out-sourcing vs. in-sourcing set to very long term market cycles.

Several panels touch on infrastructure finance with GPIF mentioning their joint investment effort with Canada’s CPP on ESG brownfield infra projects. Mizuno-san noted the challenges of crafting/originating greenfield projects as funding challenges often drive the cheap option and the cheap option is usually dirty (materials, supply chain, etc.). GPIF will not finance dirty deals, full stop.

A deeper discussion ensued on better was to measure and compensate performance with a general aversion shown to managing to qtly earnings guidance. The average hold period for SPY, the > $100bln S&P 500 SPDR, the largest ETF tracking the benchmark for US stocks is 5 days. In the last 15 years 52% of the Fortune 500 companies as no longer in existence. In 1955 the average Fortune 500 company life expectancy was 55 years, in 2015 it is 15 years. Traditional valuation metrics clearly must evolve to address the realities.

ESG toolkit for Fund Managers: http://toolkit.cdcgroup.com/

Q&A with Author of the PRI’s Practical Guide to ESG Integration for Equity Investing

The ESG investment construct must be turned on its head, to my mind. Social investing = investing and “dirty” or non-socially minded investment should be the type requiring explicit sponsor/board/member approval. JCG

Follow me on twitter @firehorsecaper

shenzhen-beach

Shenzhen “beach” September 2016

Mark Carney, Chair, Financial Stability Board (FSB). Awesome 30 minutes of your life, watch it. Carnage, indeed.

 

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INCOME FUND – PIMCO FUNDS GLOBAL INVESTOR SERIES; $PIMCMEI.ID

All investors have been extremely challenged to select plausible investments for the fixed income portion of their investment portfolio in the current environment. With so much of the world sovereign bond markets trading at negative yields, it is certainly a perilous time to be a fixed income investor. Alternative fixed income and unconstrained funds are all the rage.

This brief article introduces PIMCO’s venerable offering which is a global multi-sector fixed income fund. PIMCMEI is an open ended fund, incorporated in Ireland. The fund seeks and delivers high current income, 4.06% monthly at present. The fund duration is a modest 3.1 years.

PIMCMEI is up 4.81% year to date in 2016, compared to 7.43% for the S&P. This return  comes with a lot less drama of course, as anyone long equities through February 2016 can attest.

The MER for the retail fund is high at 1.45%. PIMIX is the institutional version with a more modest MER of 0.45% but for $1,000,000 plus invested. The standard deviation of PIMIX is 2.81% and the Sharpe Ratio is a remarkable 2.01. The Sharpe ratio calc first subtracts the risk-free rate from portfolio return then divides the result by the standard deviation of the portfolio return. As a point of reference the S&P 3 year std. dev. is 11.23% and the 3 year Sharpe ratio is 1.02.

Pimco’s Daniel Ivascyn, CIO is the PM for the fund (est. 12/2012), assisted by Alfred Murata. Ivascyn, not yet 50, took over from aged Bill Gross as the “Bond King” at Pimco. The retail targeted PIMCMEI manages > $15bln and PIMIX has > $60bln in AUM.

I’m also long some of Gunlach’s Doubleline funds, but nowhere  near the scale.

Wealth managers like the consistent Pimco Income Fund returns and offer up to 4x leverage on investment in the fund at Libor +50/+75 depending on the size of the relationship one has.

Clearly this fund gets many things right. The brain trust at Pimco is substantial and all PM’s benefit from the rigorous Secular forum, run annually, which looks out 3-5 years. The sister Cyclical forum takes a 12-18 month view and between them have allowed Pimco to get to the carrot first,  in size.

For non-US investors, the PIMCMEI fund attracts no withholding tax and is not subject to US estate taxes given the Ireland domicile.

The fund fact sheet can give you a good window on where Pimco currently sees value. Weighting in high yield are low in comp to emerging markets. The highest weighting is in US mortgage backed securities at present.

Don’t write off fixed income just yet, you just have to dig.  JCG

Disclosure: Long PIMCMEI levered 1:1. Leverage to be reduced as 3 month Libor setting reaches 1% (mid 2017?).

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NINTENDO $NTDOY- MOBILE, THE SECOND COMING

Pokemon Go, get used to hearing a lot more about it.

Thus far the limited release, including the all critical USA market, has been record setting.

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From a trading perspective, the pin action has been awe inspiring, but without the wide trading ranges one would expect of daily double digit gains in the stock price of Nintendo. Buys have been exceeding sells by a factor of 7:1 on some platforms over the last week. Lower left to upper right as Gartman would phrase it. Nintendo officially has game, mobile game.

The global roll out of Pokemon Go is underway. I’m reporting from Japan, home of Nintendo (ticker 7974 on the Tokyo Stock Exchange), where fans can’t wait to get access to the app and begin their frolicking. The Japan roll out appears to have been set coincident with the end of the rainy season in Japan. As an outdoor “augmented reality” experience, Pokemon Go is best launched without torrential rainfall, hence I expect a release date the last week of July. The rain spigot ceases like clockwork around the 20th of July in Japan. Expect take up rates on app downloads, usage, paid users, $1 pokeball sales and overall hype to pierce the giddy precedent set by the US market.

The opportunities for Nintendo to exploit their extensive catalogue of intellectual property is immense. Pokemon, developed in 1995 by Satoshi Tajiri was already raking in $2bln in revenue per annum for Nintendo. Generations of gamers know the sketch, keeping advertising cost down and hence margins high. Others have pointed to the immense retail deals that could result with global franchises keen to build a stable of pokemonsters to drive traffic and resulting $. Poketourism can’t be far behind, I kid you not.

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The many, including me, not yet long should study further for rational entry points. Shorting this rocket is not something characterized as an investment activity and should not be considered.

Nintendo has over $7bln on cash on their balance sheet and no debt. The previous high in the ADR’s was $78.50 in 2007 and there are 15% less shares outstanding now (held as Treasury stock by Nintendo, now the largest sole shareholder of Nintendo stock via timely buybacks at much lower levels).

The current $33.38 price for the ADR’s has come too fast, but it is difficult to fade this move for the multitude of reasons noted. Nintendo has a market cap of $32bln at present.

Pokemon Go was developed by Niantic Inc., a Google spin off which Nintendo holds a 32% stake in (yet another reason to own Alphabet too). One can bet there are many more augmented reality games in the wings. No gaming company has been more successful than Nintendo, who have brought 22 of the top 25 console games to market over the history of the gaming space.

The previous stock price pinnacle of JPY 75,000 (we closed at JPY 27,780 Friday last) was achieved when Nintendo’s Wii console took the market by storm, selling >100mm units. There are 2.5bln smartphones in use globally at present, and growing. Candy Crush has the record to date for smart phone penetration at 20% and it would appear Pokemon Go could easily exceed that metric. Those early to the story in January 2016 saw 3-4x upside for Nintendo shares. The recent spike of near 2x since the limited Pokemon Go launch clearly increases the risk for new holders, but it would appear a mobile gaming juggernaut has emerged in Nintendo.

For those that feel restricted trading only North American hours, the more liquid parent listing denominated in JPY, 7974.to is another option for those enabled to trade on foreign exchanges. Any medium to long term hold would be best currency hedged, as even though the JPY has rallied 15%+ at points in 2016 seems destined to depreciate versus the USD.

Play safe and trade safer. JCG

PS: Follow me  on twitter, Caleb Gibbons @firehorsecaper

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$ICPT : INTERCEPT PHARMACEUTICALS, INC., – BIDDING PADDLES READY

Intercept Pharmaceuticals, Inc., waiting until almost midnight, the Friday before the Memorial Day long weekend, 5/27/16, announced the FDA approved Ocaliva (Obeticholic Acid) for the treatment of the liver disease PBC (primary biliary cholangitis), formerly known as primary biliary cirrhosis. Approval was largely expected (the FDA Advisory Committee had previously voted 17-0 in favour), but the good news appears to be that the conditions attached to the approval are modest. Safety concerns had some worried that sales could be hampered by restrictions on use in patients with moderate or severe hepactic impairment, but the prescription label has no such restrictions from my reading of it (link for your perusal): ocaliva_pi

PBC is a rare, autoimmune cholestatic liver disease that puts patients at risk for life-threatening complications. PBC is primarily a disease of women, afflicting approximately one in 1,000 women over the age of 40.

Sales of OCA will begin In 7-10 days and expectations are that peak sales could reach $2.6 billion per annum. $ICPT closed Friday at $141.77 with a market cap of $3.5bln. With a typical valuation of 7x sales, clearly there is scope for a rally from here. ICPT’s float is small at 17.44mm shares and 3.4mm shares (19.5%) are held short. 78.5% of the shares are held by institutions. Fidelity Investments is the largest holder with almost 15%. The lifetime high for the stock was $462.26, which will not likely be eclipsed until OCA for NASH (fatty liver) is approved in early 2019, which obviously depends of the results of the 2,000+ patient Phase III global trial.

Another likely scenario is an approach from a larger player seeking a blockbuster drug to add to their stable. With OCA approved for PBC there is now a risk buffer to await the 2018 outcome of the phase 3 “Regenerate” trial for OCA in the treatment of NASH. Nonalcoholic steatohepatitis (NASH) is a significant metabolic form of chronic liver disease in adults and children effects a much larger percentage of the population that PBC. The OCA dosage for the treatment of PBC are 5-10mg whereas for NASH the trial is being conducted at dosages of 10 and 25mg. There are currently no drugs approved for the treatment of NASH and OCA for PBC is the first liver drug approval granted in the last 20 years. PBC & NASH are distinct, progressive liver diseases. Both diseases may lead to fibrosis and cirrhosis of the liver. From a valuation perspective most would argue 20% to the PBC application of OCA and 80% to the much larger NASH opportunity.

XBI the SPDR S&P Biotech ETF is -26% ytd in 2016. ICPT is the 4th biggest holding in the ETF at 2.6%.

What lies ahead:

Next week analysts will be tweaking their ICPT numbers based on the terms of the OCA for PBC approval. Most recently MS moved to underweight with a price target of $80. Stingy indeed when ICPT have > $22 a share in cash on their balance sheet! Merrill Lynch have an underperform on the stock and a $144 target. ML used to be the biggest bull on ICPT, with a target > $800 per share when Rachel McMinn Ph. D covered them, before joining Intercept Pharma as Chief Business & Strategy Officer in April 2014.

The street conjecture will also begin as to the timing of a bid and take-out premium likely on a bid for ICPT, now that a level of uncertainly has been removed. JCG

Disclosure: Long ICPT, 3% weighting, trailing stops, not inclined to sell < $200.

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