It was recently announced that Arena Resources, a relatively new portfolio position, will be acquired by Sandridge Energy (SD) for roughly $40 per share.
We are getting paid largely in stock (only $2.50 per share in cash) and we do not want to receive a large position in SD (risky balance sheet, natural gas-heavy e&p with inherent execution risk integrating ARD)
Instead of waiting for the deal’s completion and receiving Sandridge stock, we should sell ARD and allocate the capital into a new energy stock.
Restructuring plan will drive shareholder returns in coming years
Sell-side hates uncertainty room for analyst upgrades
Above-average dividend yield pays us to wait until market rewards stock for successful restructuring (12-18 months)
Management is focused on improving returns on capital
Selling ½ its position in Lukoil
Generate $5 billion in cash
COP was only receiving a cash dividend (insufficient return on capital)
Realize significant capital gains (paid $38 per share, Lukoil stock now at $56)
$10 billion in asset sales
These assets only generated $250 million in net income during 2009 will help improve returns on capital
Management is working to improve the balance sheet with operating cash flows and cash generated by asset sales (previous slide)
$5-8 billion to reduce debt during 2010/2011
From $28.5 billion in debt to $20.5-$23.5 billion in debt
Recently announced $5 billion in share repurchases
Reduce shares outstanding by 1-2% per quarter through 2011)
RESTRUCTURING SHOULD DRIVE THE STOCK HIGHER
By reducing interest payments & shares outstanding and divesting non-core assets, management will be able to continue increasing the percentage of cash flows distributed as dividends
Last five years: ~27%
After the completion of the restructuring: ~40%
As the chart to right demonstrates, investors in large oil companies reward dividend-friendly management teams.
ROOM FOR UPGRADES
Wall Street likes ‘predictability’ – the restructuring makes earnings/cash flow forecasts and estimates quite difficult.
The successful execution of its restructuring plan will compel analysts to upgrade COP.
Currently, 12 of 18 firms covering the stock rate it a hold (10) or sell (2)
“ We think it might be premature to venture into the stock and would opt to stay on the sidelines until we see more concrete evidence of an improving return trend.” – Barclays (Neutral)
“ While our view of ConocoPhillips has directionally brightened, there is no change to our Neutral rating.” – GS
The successful completion of the restructuring (18-24 months) should push the stock up 20-40%, due to improving returns on capital, multiple expansion, and fewer shares outstanding.
Management recently announced a 10% increase in the dividend, now at $2.20 per share or 4.2%
In other words, we—as shareholders—are compensated (in cash) to wait for the restructuring plans to materialize, the analyst community to jump on-board, etc.
S&P Yield: 1.79%; XOM, CVX, and OXY all between 1.50%-3.50%
Purchase Date: 2/27/2007
Purchase Price: $209 (peak ~$250 in ‘07)
Number of Shares: 35
Last Trade: $179.12 (-.21%) (Friday’s Close)
Total Gain: -$1,045 (-14.3%)
Portfolio Weight: $6,270
Smallest Position in Our Portfolio
GS - WHO ARE THEY?
Often considered the savviest bank on Wall Street (and highest paid)
Operate in over 30 countries with 42% of the staff from outside the “Americas”
2009 44% of revenues from outside “Americas”
Once the largest “pure investment bank” by NI, B/S, and Market Cap (prior to Sept. 2008)
Sept. 2008 – became a “bank holding company”
GS - BUSINESS
Operates in 3 main business segments:
Trading and Principal Investments
Asset Management and Securities Services
1. INVESTMENT BANKING
Financial Advisory –
Mergers and Acquisitions advisory services
Financial Restructuring advisory services
Equity and Debt underwriting
In 2009 Investment Banking represented 11% of their overall revenues
2. TRADING AND PRINCIPAL INVESTMENTS
Fixed Income, Currency, and Commodities (FICC) –
Consists of a lot of derivatives products and activities ranging across commodities, currencies, and credit
Also, mortgage related securities, loan products, and other asset-backed instruments
Investing in equity securities and derivatives, and exchange-based market making activities (and even insurance activities)
Made in connection with “merchant banking activities”
Investment in shares of Industrial and Commercial Bank of China Limited
In 2009 represented 76% of their overall revenues.
3. ASSET MANAGEMENT AND SECURITIES SERVICES
Asset Management –
Investment Advisory services, financial planning, and investment products across all major asset classes and to institutional and individual investors
Manage the merchant banking funds
Securities Services –
Prime Brokerage, Financing Services, Securities Lending
In 2009 represented 13% of overall revenues
BANK HOLDING COMPANY
Now a combination of investment-banking operations with larger capital cushions that come with retail deposits.
Submit themselves to greater regulation (under supervision by the Fed) – e.g. higher capital requirements (less leverage)
“The high-risk, high return days may be in the past for this firm…” (Morningstar)
Could be bad with 76% of revenues coming from principal investments (proprietary trading)
When economy picks back up, don’t expect GS profits to return to pre-crisis levels
2009 2008 Total Assets 848,942 884,547 Total Liabilities 778,228 820,178 Total Equity 70,714 64,369 Debt/Assets 0.92 0.93 Debt/Equity 11.01 12.74
Put forth by Paul Volcker (former Fed Chairman under Carter and Reagan)
Now chairman of the “Economic Recovery Advisory Board” under Obama
Prevents commercial banks from owning or investing in hedge funds, private equity, and limits the trading they do on their own account (“prop trading”) the key to Goldman’s Business Model (~10% of revenues)
Goal: “Create a sound economic foundation to grow jobs, protect consumers, rein in wall street, end too big to fail, prevent another financial crisis”
For the Year Ended 2009:
EPS of $22.13 vs $4.47 for Fiscal year 2008
Stock saw a total return of 101.9%
Beat Quarterly earnings consensus every quarter
Repurchased preferred Stock from the Government, one of the first banks to do so
Total return of $11.42B
Short-Term (Gains or Flat?):
Selling at about 9.5x estimated earnings and 1.4x projected year-end book value (fair multiples for short-term)
Forbes – Goldman shrank its compensation by $10B (to about 36% revenue) which boosted ROE to 22.5%. If they maintain this level it could be good, if they boost compensation back to 40% Revenue range, stock could be flat.
Although facing pressure on trading portion of their business they are well-positioned in the investment banking field for the “comeback of M&A” (up 20% over 1Q 2009) – IB ~$5B in revenue (only 11%)
Goldman Ranks 3 rd in 2010 league tables for global M&A by volume
Lagging financials so far this year, so expect a continued comeback, but no expectations for it reach pre-crisis levels
Big Banks lowering leverage an average of 42% prior to reporting it to the public over the past 5 quarters (WSJ).
Although masking their risk levels, could still potentially boost profits once again at Goldman Sachs, but don’t expect it to last.
Long-Term (conflicts of interest?):
“ We facilitate client transactions with a diverse group of corporations, financial institutions, investment funds, governments and individuals through market making in, trading of and investing in fixed income and equity products, currencies, commodities and derivatives on these products. We also take proprietary positions on certain of these products .”
“ Demanding unequal arrangements with hedge-fund firms, forcing them to post more cash collateral to offset risks on trades while putting up less on their own wagers. At the end of December this imbalance furnished Goldman Sachs with $110 billion, according to a filing . That’s money it can reinvest in higher-yielding assets.”
About a week ago Goldman sent out a letter to shareholders (8 pages, longest ever annual letter) defending its position that it did not take “short positions” to bet against their clients.
Yet they were one of the first banks to short the residential real estate market (MBS) claiming that they just used those short positions to “offset their long positions” – whether they did or not the possibility of it happening is not good.
FINANCIAL ELEVATOR PITCHES
GFI GROUP (GFIG)
What is an interdealer broker?
Limited capital commitment
Importance of employees, technology, and relationships
Used the crisis to add brokers from struggling firms
The stock should advance 100-150% as the operating environment normalizes.
Insiders agree – own 44% of shares outstanding
HOW TO THINK ABOUT THE STOCK
As the environment normalizes and brokers return to previous efficiency levels ($900k + in revenue), the brokerage business will earn $50-60 million, or 40 to 50 cents per share.
In a normal environment, the market values interdealer brokers at 20-30x earnings; making the brokerage worth $8-$15 per share
Because of its place as a middleman in many transactions, GFI has access to important data flow. The company’s growing software division sells market data and analytics products for building pricing models, developing trading strategies, and to manage, price, and revaluing derivative portfolios.
Because the brokerage business is so undervalued by the market presently, we are getting this highly profitable, rapidly growing business for free at the current price.
EVR – WHAT DO THEY DO?
Independent Boutique Investment Bank founded in 1996 (went public in 2006)
“ Independent” = No commercial banking or proprietary trading activities.
Removed from the conflicts of interest often created in large financial institutions with multiple products (a lot of what regulation is aimed at)
Specializes M&A Advisory, other financial services advisory, and asset management.
2 Segments: Advisory (e.g. M&A) and Investment Management
Offices in New York, San Francisco, Boston, D.C., Los Angeles, Houston, London, Mexico City, and Monterrey
Large objective to grow globally
MERGERS AND ACQUISITIONS
Thomson Reuters – 1Q 2010 value of global mergers and acquisitions = $573.3B, a 20.5% increase of 1Q 2009 – the “comeback of M&A”
Ranked 11 th in terms of M&A revenue
Last year not even ranked, now 2.3% market share
Advised restructurings of GM and CIT group, advised Wyeth on $68B takeover of Pfizer, Inc., and advised Burlington Northern on its sale to Warren Buffet’s Berkshire Hathaway
Reported 4Q 2009 profit of $16.5M ($0.41/sh) on $109M of revenue (2008 = -$0.25/sh)
$99.2M of that revenue due to M&A (87% total revenues for ‘09 came from advisory services) and restructuring activity – a significant portion from restructuring, but…
“ Restructuring likely to take a backseat to M&A in 2010…We are in the early stages of a classic 5-7 year M&A up cycle” – Roger Altman, founder and chairman of EVR
Conference call (4Q 2009): firm expected to receive its underwriting license and license to trade equities in this quarter (2Q 2010).
Acquired Atalanta Sosnoff, an independent registered investment advisor.
Ralph Schlosstein (co-founder of Blackrock and EVR CEO as of May 2009) said: “should be immediately accretive to earnings”
Acquired Neuberger Berman: “expected to establish a broader presence in the United States and expand its reach across continental Europe and the Middle East.”
Also, plans to expand into Brazil and Mexico as they continue to broaden their global footprint
Goldman Added EVR to “conviction buy list”
As long as M&A volume continues to increase Evercore is well-positioned to take a growing piece of the market share (already have as seen above)
Moreover, with the underwriting license they will be able to offer a wider range of advisory services, continuing to boost their market share.
REINSURANCE GROUP OF AMERICA
Life Reinsurance (#2 in US, #3 Worldwide)
What is Life Reinsurance?
Customer is Primary “Cedent” Insurer
Transfers Risk, Frees Up Capital
More Specialized, Niche Business
$20 Trillion Life Insurance in Force in US
$8.1 Trillion of Life Reinsurance in Force
5 Largest Reinsurers Have 71% of Market
HOW (RE-)INSURANCE WORKS
Companies Make Money (in theory):
Premium Income Less Claims Expense
Life reinsurance spread mainly driven by mortality
RGA has particular expertise in this area
“ Float” comes from the time delay between collecting premiums and paying out claims
Investment income is turning up after sub-par/poor performances in 2007 and 2008
Favorable Industry Economics
Primary Life Insurers Face Capital Constraints
Reinsurance Consolidation = Pricing Power
Stable Double-Digit ROE
Diversifies Financial Sector Exposure
Midpoint EPS = $6.60 (8x Earnings)
Over-Capitalized ($500 Million), 1x BV
A global provider of electronic payment and transaction processing solutions for financial institutions, retailers, service providers and consumers
Operates in 3 Segments
Electronic Financial Transactions (EFT)
Money Transfer (22%)
PAYMENTS = STABLE BUSINESS
International business has seen sluggish growth during recession, but transaction volume returns with global consumer
ATM networks, Point of Sale solutions, Credit/debit card prepaid & outsourcing, prepaid mobile
India, Germany, Czech Republic, Egypt, China, etc.
~80% revenues generated ex-US
Enterprise Value / EBITDA Multiple of 7x
$929 mln + $256 mln cash - $320 mln l-t debt
2009 EBITDA @ $140 million
Recent weakness in prepaid segment could signal a bottom as volumes return
Management has been paying down debt with FCF, creating a more nimble company