10foot Scuttlebutt: May edition

10foot Scuttlebutt: May edition

Dear readers. As with previous months, here are some things I’ve seen or thought recently.

The Magic Pudding business model

In my recent look at the mineral sands sector, I came across a remarkable business, namely the Mineral Commodities Limited (ASX: MRC) Tormin Sands project. Every year the ocean washes up minerals like zircon, ilmenite (titanium feedstock), and garnet onto the beach. Tormin scrapes off the top part of the beach and processes it, achieving very high concentrations of minerals. By the time Tormin finishes scraping the whole beach, more resources have washed back in and it is time to start again.

Over 4.5 million tonnes (5% of which is Zircon) have been processed this way over the past few years and the company’s resource estimates there’s another 1.8 million tonnes or so remaining, although the rate of replenishment has been falling.

There is something fundamentally bizarre about having a mine that literally washes up on the beach every year. I can’t imagine how you would build a business around such a thing. I deliberately mis-characterise it, but you can just imagine telling your bankers “yeah so actually we haven’t got any minerals there at the moment, but if you wait another 6 months, we will have. Honest!”

Brilliant.

Notes from the Blue Allied Sky Capital presentation

Yours truly was a recent guest at one of the Blue Sky roadshows (thank you to BLA shareholders for the steak and diet Coke). The whole Blue Sky team was there, and it seemed to me that there was a party line, and everybody stuck to it. Here’s my take on what was said, drawing from my notes of the presentation:

“Valuations are consistent, genuine, and validated by third party valuers. The market does not understand Blue Sky’s business, that is why disclosure is increasing, to help the market understand. Now that disclosure has improved, this is going to let people go out there and try poke holes in things if they wish. Not disclosing information like FUM is a competitive advantage, because if people know how much dry powder we have to deploy, then they will try to charge us more for an asset. FUM is $4 billion, Glaucus $1.5bn is wrong.”

This $4bn figure was hewed to consistently. In fairness if you’re charging mgmt fees on $4bn, whether that be undrawn debt or not, then I think it could be technically correct to say that you have $4bn FUM. That doesn’t make it OK, but I know that others have looked at this in more depth, and they are welcome to comment below.

There were also a few extremely irritating hints that I felt were borderline material non-public information about how Blue Sky is sitting on oodles of dry powder due to recent & constant strong interest from institutional investors – ah, but we can’t tell you how much dry powder we’ve got, that’s a secret.

Setting aside the wisdom of hosting steak dinners at the Hilton for several hundreds of shareholders (and tourists) during a time of financial stress, the thing that struck me most about Blue Sky was its similarity to the Allied Capital story, which I have been re-reading.  I’ve tweeted about this previously:

“Criticism from shorts is centered on two allegations. They say [ ] is taking excessive money from [ ] in payments and fees. Second, they claim that [ ] … is nothing more than a sham company reminiscent of [ ]. These allegations are totally baseless.” #blueskyoralliedcapital?

— 10footinvestor (@10footinvestor) April 22, 2018

Having recently re-read the book, some of the things that Blue Sky management said I found quite interesting. Here’s my take on what I remember from the Blue Sky presentation, based on my scribbled notes, which may not be 100% accurate:

“The market doesn’t understand our business, that’s why we are greatly increasing disclosure to explain how we work.” (Allied Capital was also famously misunderstood by short sellers)

“We have a consistent, genuine, and third party valuation policy.”

“If you look at our sale price relative to our most recent carrying valuations, 6/9 investments were sold above carrying value with an average premium of 30%.”  (A criticism of Allied Capital was that, since the sales usually took more than a quarter to structure, the carrying price could be marked close to the sale price and thus the relative premium was not necessary reflective of the historical carrying value. I am not accusing BLA of that, only remarking on the similarities and a potential issue with this methodology, especially in light of apparently volatile valuations at one investment which I’ll get to below.)

I stress here that I’m not accusing BLA of being criminal or engaging in illegal behaviour like Allied Capital allegedly did. The similarities to my mind come from the fundamental risks of the business model – the opacity of valuations, the high fees from managed entities, and the high degree of trust that a shareholder must place in the company to do the right thing by them.

Blue Sky Brass Tacks

That aside, there were a few other comments that I thought were questionable. Again this is just my take, which may not be completely accurate. A Blue Sky investor asked in a roundabout way:

“I am an investor in Student Accommodation Fund #7, why was my NTA valuation $1.50 in October, $2.04 in December, and a 35 cent downgrade in April?”

Blue Sky:  “Well in October our occupancy was 82% (?) and this went up to 95% in December, and then in April occupancy was down at 73%(?).”

Aggrieved Shareholder: “Yeah but from $2.04 to mid-70s (I assume mid $1.70s) four months later..? I also find it strange that when you said you disagreed with the valuation [the valuation suggested by the asset valuer], you went along with the higher valuation even though you disagreed with it.” 

Blue Sky:  “Well as conditions change, we have to update our models. We also found that there has been a large increase in capacity in this market, so there’s been a change in student buying behaviour. The current market definitely favours the student and we are having to offer more flexible terms and prices, which also had an impact in addition to lower occupancy.”

Aggrieved Shareholder:  “I have no faith in your valuations.  That is a statement, not a question.”

There were several possibilities that stood out to me about this.

• Marking the valuation up as soon as occupancy increased. 95% occupancy I think is a fairly aggressive assumption to build a multi-year valuation on, especially if you were previously using 82% and then it goes to 95% 2 months later and you extrapolate that out into the future to generate a sizeable increase in NTA (from $1.50 to $2.04).
• May not have marked the valuation down until forced to (April being post-Glaucus)
• Seeming lack of awareness of coming boom in supply. Student accommodation construction is a long lead time business and I would have thought that with 7 student accom funds, low interest rates, and a fiduciary duty, BLA would (should) have a good grasp of when new competition was likely to arrive.
• Using 95% occupancy as an input into the valuation combined with the lack of awareness of supply is a potential double-whammy for overvalued assets. I also didn’t hear any mention of use of a forecast- or rolling three year- occupancy or something like that. Perhaps an average was used, but I felt it wasn’t clear from the answer, and given the magnitude of the NTA increase it does appear the assumptions were optimistic.

 

There was another shareholder who perhaps unintentionally struck to the heart of the issue when he supported management:

Hotelier Shareholder:  “I’ve spent my whole life building and developing hotels and I can tell you for an absolute fact that it is simply impossible to value any development site when it’s under development.”

Cynical 10Foot, to himself:  “You are paying this company that establishes valuations and charges you significant fees on said valuations, for managing your investments in development projects which you have just told us are impossible to value in the development stage. So what are you paying for?”

Hotelier Shareholder, continuing: “I’m a happy shareholder, but I’m wondering – why are your shares so cheap?”

Blue Sky:  “The share price is sentiment driven. I mean look at Bellamy’s, it collapsed from $15 to $3 last year, and now it’s back over $20. Completely sentiment driven. We are a rapidly growing company and sentiment is against us right now and that puts a hold on things for a while. Sentiment is against us now too, but in time it will turn and we’ll recover.” (technically true re sentiment-driven, but I think that also overlooks that underlying demand for BAL product was red hot, whereas demand may have changed starkly with BLA, if recent profit downgrades are a guide).

There were a few other Blue Sky statements that stuck with me, although again, this is just my take on them, which may not be 100% accurate:

“How much capital do we have available to deploy? We’d love to tell you, but it’s confidential. Advertising how many hundreds of millions we have makes it harder for us to buy. It’s not in shareholder’s interests for us to disclose this sort of information.”

“Class action firms were likely tipped off by Glaucus given the speed with which they filed suit after the Glaucus report came out.”

“The media loves to sell negative stories and I mean look at the trouble that massive businesses like AMP, Commonwealth Bank and so on are having telling the positives of their story at the moment. We’re here and we’ve stood up to try and tell our side of the story but we are not getting the coverage because bad news sells, and if you look at the headlines, it’s clickbait, so people click on it because they want to see what the latest negative thing is, and that makes it very hard for us to tell our story.”

“We are co-invested in our own funds, almost everybody at the firm is. This is about telling our side of the story.”

Hate it or love it, Blue Sky aficionados are welcome to comment.

David Einhorn gets the joke:

https://youtu.be/Qvz5LS9pIjs?t=1379

I recommend watching about 50 seconds from the part of the video that I’ve linked above. This is something that I’ve linked before on Twitter – the whole presentation is great – but this part really resonated with me and I think it will resonate with others also.

This “getting the joke” quote is the best that I’ve heard in many years, and I think it outshines even Buffett and Munger in terms of explaining the motivation of certain investors to excel.

Einhorn is probably my favourite investor. I think he has several flaws – mostly notably shorting bubble stocks on valuation and seemingly ignoring the impact of hype (market rationality, your solvency, something something) – and I don’t know if I could ever make any investor my true personal hero, but if there was an investor I most aspire to be like, it is David Einhorn.

The 10foot spreadsheet

I recently had a request to share my Google Sheets spreadsheet where I track my portfolio. You can access a public & out of date version of it below.  I will never update this, and it could be deleted at any time, but you are welcome to either look at or copy the structure that I’ve used for tracking buy & sell prices and performance. You should be able to save or copy your own version. Any problems accessing it, leave a comment & I’ll fix it. (And if you spot any errors, let me know about that too.)  This version can’t be edited online, but if you download it then you should be able to edit it for your own purposes after downloading.

https://docs.google.com/spreadsheets/d/1BbxmjXpUXSXXV5EQnSfstaQs3oyWmd6qE4pIlagPLNw/edit#gid=0

It’s not elegant, and it’s a bit rough because I realised right towards the end that I wouldn’t be able to add cash to it easily – I need to convert it into a unit structure. At the moment I track the $ value of the whole portfolio to measure performance, so if $10k goes to $11k that’s +10% performance. However if I add cash to increase the size of the portfolio to $15k, that looks like a +50% investment return in this spreadsheet. I need to convert to a unit basis where I have say 10000 units at $1 NAV apiece, so if I add $5k I just add 5000 new units at $1 and NAV per unit stays flat. That’s something I’ll try to before the next quarterly in June. I may also look to upload a public version of the ‘unit’ spreadsheet once it’s done.

Cheers!

I have no financial interest in any company mentioned. This is a disclosure and not a recommendation. 

In the interests of full disclosure, this author recently attended a public Blue Sky presentation and was fed, watered, and Diet Coca-Cola’ed by the asset manager. I guesstimate this resulted in a ‘in-kind’ benefit to me of around $100. I have no relationship with Blue Sky or any of its funds or staff whatsoever.

The above Blue Sky quotes were drawn from my scribbled notes and my best recollection of the public Blue Sky presentation on 16/05/2018. I have done my best to be true to what was originally said, but I don’t warrant that it is 100% accurate.