An Overview of the Housing and Economic Crisis,           Why There Is More Pain to Come,               and Two Investment...
Background on the U.S. Housing Market
Private Label Mortgages (Those Securitized byWall St.) Are 15% of All Mortgages, But Accountfor 28% of Nonperforming Mortg...
More Than 14% of Mortgages on 1-to-4 Family HomesWere Delinquent or in Foreclosure as of Q3 2009                          ...
All Types of Loans Are Seeing a Surge inDelinquencies, Led by Subprime                               45%                  ...
The Mortgage Crisis is Shifting From One inWhich Defaults Are Driven by Resets to BorrowersLosing Their Jobs and/or Going ...
The Mortgage Meltdown Has MovedBeyond Subprime to Five Other Areas                        Prime Mortgage                Co...
Delinquencies of Prime and Alt-AMortgages Are SoaringSource: New York Times, 5/24/09.                                   8
Foreclosure Filings Have Increased    Dramatically•    332,292 foreclosure filings during October were down 3% sequentiall...
The Delinquency and Foreclosure ProblemHas Spread Far Beyond the Bubble States Source: LPS Applied Analytics, WSJ 10/22/09...
Two Waves of Losses Are Behind Us…But Three Are LoomingLosses Mostly Behind Us• Wave #1: Borrowers committing (or the vict...
Why Won’t the System Collapse Again?          Given that the three looming waves are much larger than the two that are mos...
Current Status of the Housing Market
Existing Homes Sales Have Risen in Recent Months, Leadingto a Decline in Inventory – But Inventory Is Still Well AboveHist...
Defaults Are Massively OutpacingLiquidations, So the InventoryOverhang Continues to Worsen                                ...
The Current “Housing Overhang” Is 7 Million Homes –Which Doesn’t Include Any New Defaults, Which AreRunning at Approximate...
Outlook for Housing Prices
Home Prices Were in an UnprecedentedFreefall Until A Slight Bounce in Q209          220                           S&P/Case...
Home Prices Look Affordable Due to PriceDeclines and Ultra-Low Interest Rates                             800             ...
Another Wave of Resetting Loans Is On the HorizonThe Last Wave Was Driven By Subprime Loans;This Time, It Will be Option A...
Banks Are Selling Their REO, ButForeclosures Have Plunged By More ThanHalf, Ballooning the Inventory Pipeline             ...
One Third of All New Single Family HomeSales Are Financed With FHA or VA Loans       Number of FHA Loans Insured          ...
FHA’s Loan Book Is a Rapidly Growing Disaster17.9% of Loans Are in Some Stage of Default;For 2007 Loans, It’s 32.4% Source...
Existing Home Sales Are Highly Seasonal Source: National Association of Realtors.                                         ...
Existing Home Sales Are Highly Seasonal                               HPA Seasonality Coefficient -- Deviation From Mean S...
Home Prices Increased Every MonthFrom May-September…                                 Sequential Home Prices March 2005-Sep...
…But They Always Bounce in the Springand Summer!                              Sequential Home Prices February 2000-Septemb...
Current Economic Situation
There Have More Than 8 Million Jobs Lost So Far in ThisRecession, Though the Monthly Rate of Losses Has Easedin Recent Mon...
The Unemployment Rate Continues to Rise,Reaching 10.0% in November, Though This isDown from 10.2% in October   If part-tim...
Chronic Unemployment Is Skyrocketing                                          38.3%Source: Labor Department, WSJ, 10/3/09....
5.3% of All Jobs Have Disappeared, WorseThan Any Recession Since the Great Depression                                1948 ...
Consumer Confidence Has ReboundedSomewhat But Remains Low                                         160                     ...
Mortgage Equity Withdrawals of Roughly $400Billion Annually During the Peak Bubble YearsFueled Unsustainable Consumer Spen...
Many Borrowers Used Cash from Refinancings(Cash-Out Refis) and HELOCs to Buy New Cars  •    As home prices have declined a...
Total Consumer Credit Is Falling Sharply          Total Amount of Revolving and Nonrevolving    Total Consumer Credit Outs...
The U.S. Savings Rate Hit a 15-Year High of 6.9%in May, but Fell to 3.0% in AugustThis is good news in the long run, but c...
Household Liabilities as a Percentage ofDisposable Income Remains Very High                                               ...
Where We Are Finding OpportunitiesSeven Months Ago, We Were Playing Offense; Now We’re PlayingDefense, As We Trim Our Long...
Investment Idea #1          Short the Homebuilders Via theiShares Dow Jones US Home Construction ETF (ITB)
Housing Starts, Completions and SalesAre At or Near All-Time Lows                                           2000          ...
Ja                Median Age (months)                                              n-                                     ...
Vacant Housing Stock Creates anEnormous Inventory Overhang                                              1.1-1.5 million ex...
Nearly 6% of Homes Built This DecadeAre Vacant                                          Vacancy Rate By Date of Constructi...
Unlike Past Housing Downturns, New Home SalesHave Fallen Far More Than Existing Home Sales                                ...
Debt-to-Equity Ratio ofMajor Homebuilders                                                                                 ...
Inventory-to-Equity Ratio ofMajor Homebuilders               4.0                                                          ...
Price-to-Book Ratio ofMajor Homebuilders               3.0                      2.69                                      ...
Investment Idea #2  Iridium (IRDM)
Overview •   Iridium is the world’s only communication provider with the ability to provide     real-time voice and data c...
Iridium Serves Many Different MarketsSource: Company presentation, 6/09.                                        51
A Highly Attractive Business• Growing market share in a growing industry• Huge barriers to entry• US Department of Defense...
Iridium’s Market Share Has Grown RapidlySource: Company presentation, 9/08.                                           53
Iridium Has Shown Extraordinary Growth inSubscribers                           Up 16% YOY in Q3 ’09 to 359,000 subscribers...
Iridium Has Shown Extraordinary Growth inRevenue and Operational EDITDA           In Q3 ’09, revenue declined 4% due to we...
Subscriber Growth Has Been Driven byCommercial and Machine-to-MachineSource: Stifel Nicolaus, company filings.            ...
Iridium’s Stock Has Tumbled Since It BeganTrading in Late SeptemberSource: BigCharts.com.                                 ...
Why Is Iridium Out of Favor? • SPAC structure    – Many SPAC shareholders were just in it for the cash payout      upon co...
Iridium Came Public Via a SPACTransaction • SPACs have very poor track records in general • But Iridium was acquired by a ...
Iridium NEXT • Current satellite constellation will need to be replaced starting   in 2014    – Backwards compatible (exis...
Iridium’s Cap Ex Requirements Will Rise toFund Iridium Next, and Then FallSource: Stifel Nicolaus estimates.              ...
Iridium Should Be Able to Fund Iridium NEXT FromCash Flow, Hosted Payloads and Warrant Conversion  Source: Raymond James e...
Valuation   Share price (12/7/09):   $7.97   Shares outstanding:      68.2 million   $7 warrants              13.5 million...
Iridium’s Operational EBITDA is Projectedto Double in Only Three YearsSource: Raymond James estimates.                    ...
We Expect a Mid-20% IRR on ThisInvestment for Many Years to Come    Stock Price Based on EV/EBITDA Multiples    Multiple  ...
Drivers of Stock Price Appreciation • Low current valuation multiple (40% discount to closest public comp,   Inmarsat) • R...
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Whitney Tilson VIF 2009.

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Whitney Tilson, Managing Partner, T2 Partners.

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Whitney Tilson VIF 2009.

  1. 1. An Overview of the Housing and Economic Crisis, Why There Is More Pain to Come, and Two Investment Ideas By Whitney Tilson, Managing Partner T2 Partners LLC and Tilson Mutual Funds Value Investing Forum 2009 Mexico City December 8, 2009The latest version of this presentation is regularly updated at www.valueinvestingcongress.com
  2. 2. Background on the U.S. Housing Market
  3. 3. Private Label Mortgages (Those Securitized byWall St.) Are 15% of All Mortgages, But Accountfor 28% of Nonperforming Mortgages Approximately two-thirds of homes – 56 million – have mortgages, worth a total of $11 trillion 15% of the mortgages that were sent to Wall Street account for 28% Private Label of the nonperforming loans Universe $1.7T Unsecuritized $4.0T Agency MBS $5.2TSource: Inside Mortgage Finance. 3
  4. 4. More Than 14% of Mortgages on 1-to-4 Family HomesWere Delinquent or in Foreclosure as of Q3 2009 16% 14% Percentage of Home Loans 12% 10% 8% 6% 4% Source: National Delinquency Survey, Mortgage Bankers Association; T2 Partners estimates. Note: Delinquencies (30+ days) are seasonally adjusted. 4
  5. 5. All Types of Loans Are Seeing a Surge inDelinquencies, Led by Subprime 45% Alt A Option ARM 40% Jumbo Subprime 35% Prime Home Equity Lines of Credit 30% Percent Noncurrent 25% 20% 15% 10% 5% 0% Q 99 Q 99 Q 00 Q 00 Q 01 Q 01 Q 02 Q 02 Q 03 Q 03 Q 04 Q 04 Q 05 Q 05 Q 06 Q 06 Q 07 Q 07 Q 08 08 19 19 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 1 3 1 3 1 3 1 3 1 3 1 3 1 3 1 3 1 3 1 3 QSources: Amherst Securities, LoanPerformance; National Delinquency Survey, Mortgage Bankers Association; FDIC Quarterly Banking Profile;T2 Partners estimates. Note: Prime is seasonally adjusted. 5
  6. 6. The Mortgage Crisis is Shifting From One inWhich Defaults Are Driven by Resets to BorrowersLosing Their Jobs and/or Going Underwater 60% ($250,000) 2006 Origination California Mortgages Example: Equity Relative to First Lien ($200,000) First-lien (Right Axis Inverted) 50% mortgages in Cumulative Default (Left Axis) ($150,000) California that were originated in Equity Relative To First Lien ($) Cumulative Default % 2006 went from 40% ($100,000) $165,000 of equity to an ($50,000) average negative 30% equity of $0 $149,000 by Sept. 2009. 20% $50,000 The cumulative default rate $100,000 tracked this loss 10% of equity, rising $150,000 from 1.0% to 48.5%. 0% $200,000 Jul-07 Nov-07 Jul-08 Nov-08 Jul-09 Jan-07 May-07 Jan-08 May-08 Jan-09 May-09 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09Sources: Amherst Securities. 6
  7. 7. The Mortgage Meltdown Has MovedBeyond Subprime to Five Other Areas Prime Mortgage Commercial Real Estate Alt-A Other Corporate Commercial & Industrial Subprime Subprime is only a small High-Yield / Leveraged Loans part of the problem Jumbo Prime Home Equity Credit Card Auto Option ARM Construction & Development Other Consumer CDO/ CLO $0.0 $0.5 $1.0 $1.5 $2.0 $2.5 $3.0 $3.5 $4.0 $4.5 $5.0 Amount Outstanding (Trillions)Sources: Federal Reserve Flow of Funds Accounts of the United States, IMF Global Financial Stability Report October 2008, Goldman Sachs Global EconomicsPaper No. 177, FDIC Quarterly Banking Profile, OFHEO, S&P Leverage Commentary & Data, T2 Partners estimates. 7
  8. 8. Delinquencies of Prime and Alt-AMortgages Are SoaringSource: New York Times, 5/24/09. 8
  9. 9. Foreclosure Filings Have Increased Dramatically• 332,292 foreclosure filings during October were down 3% sequentially and up 19% year-over-year.• 1.2% of all U.S. housing units (one in 84) received at least one foreclosure filing in the first half of this year. 400,000 350,000 300,000 Number of Foreclosures 250,000 200,000 150,000 100,000 50,000 0 Note: Foreclosure filings are defined as default notices, auction sale notices and bank repossessions. Source: RealtyTrac.com U.S. Foreclosure Market Report. 9
  10. 10. The Delinquency and Foreclosure ProblemHas Spread Far Beyond the Bubble States Source: LPS Applied Analytics, WSJ 10/22/09. 10
  11. 11. Two Waves of Losses Are Behind Us…But Three Are LoomingLosses Mostly Behind Us• Wave #1: Borrowers committing (or the victim of) fraud, as well as speculators, who defaulted quickly. Timing: beginning in late 2006 (as soon as home prices started to fall) into 2008. Mostly behind us.• Wave #2: Mostly subprime borrowers who defaulted when their mortgages reset due to payment shock. Timing: early 2007 (as two- year teaser subprime loans written in early 2005 started to reset) to the present. Now tapering off as low interest rates mitigate payment shock.Losses Mostly Ahead of Us• Wave #3: Prime loans (most of which are owned or guaranteed by the GSEs) defaulting due to job loss and home price declines (i.e., underwater homeowners). Timing: started to surge in early 2008 to the present.• Wave #4: Jumbo prime, second lien and HELOCs (most of which are on banks’ books) defaulting due to job loss and home price declines/ underwater homeowners. Timing: started to surge in early 2008 to the present.• Wave #5: Losses among loans outside of the housing sector, the largest of which will be in the $3.5 trillion area of commercial real estate. Timing: started to surge in early 2008 to the present. 11
  12. 12. Why Won’t the System Collapse Again? Given that the three looming waves are much larger than the two that are mostly behind us, why won’t they trigger a collapse of our financial system similar to what happened in late 2008? Answer: Last year’s collapse was triggered in part by the magnitude of the losses, but also because of the suddenness. Financial institutions can withstand even large losses if they trickle in over time because they can offset losses each quarter with profits earned during the quarter – but this isn’t possible if losses are sudden. The suddenness of last year’s losses was due in part to rapidly rising defaults, especially among subprime mortgages, but in fact, realized losses were still quite low. The real culprit was the fact that most subprime loans had been securitized into RMBSs and CDOs, turning them into tradable debt instruments. According to GAAP accounting rules, traded instruments like stocks and bonds have to be marked to market, and in only a few months in 2008, the market price for hundreds of billions of dollars of AAA- rated RMBS and CDO securities went from close to 100 cents on the dollar to the 20-30 cent range (even though the underlying pools of mortgages hadn’t yet realized much in the way of losses). This required every institution holding these securities to immediately book enormous losses, which caused many of them to collapse. Why did Merrill Lynch, Citigroup, Lehman and Bear Stearns fall, but Wells Fargo didn’t? Because Wells had almost nothing on its balance sheet that had to be marked to market. Big mark to market losses are now behind us, so it’s unlikely that there will be any sudden shocks to the system. Instead, hundreds of billions of dollars of additional losses from trillions of dollars of bad loans will be realized over many, many years. This is both good news and bad news: the good news is that while future losses will surely bankrupt many banks, especially smaller ones exposed to commercial real estate, they likely won’t threaten the system because banks are earning so much money currently that most should be able to outrun their losses. The bad news is that very high losses will plague our financial system for many years to come – our best guess is current extremely high levels for another two years, and then slowly declining for three more years before finally returning to normal levels in five years. This drip torture of high losses every quarter, year after year, will likely keep banks extremely cautious in their lending, making robust economic growth unlikely. 12
  13. 13. Current Status of the Housing Market
  14. 14. Existing Homes Sales Have Risen in Recent Months, Leadingto a Decline in Inventory – But Inventory Is Still Well AboveHistorical Levels – And Shadow Inventory Lurks Annualized Rate of Existing Home Sales Months Supply 7.5 12 11 7.0 10 6.5 9 3.6 million units, equal to 7.0 months 6.0 8 as of the end of October 2009 Millions Months 5.5 7 6 5.0 6.1 million units as of the end of October 2009 5 4.5 4 4.0 3 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Actual inventory levels are significantly higher due to “shadow inventory.” “As of July, mortgage companies hadnt begun the foreclosure process on 1.2 million loans that were at least 90 days past due…An additional 1.5 million seriously delinquent loans were somewhere in the foreclosure process, though the lender hadnt yet acquired the property…Moreover, there were 217,000 loans where the borrower hadnt made a payment in at least a year but the lender hadnt begun the foreclosure process. In other words, 17% of home mortgages that are at least 12 months overdue arent in foreclosure, up from 8% a year earlier.” Source: NATIONAL ASSOCIATION OF REALTORS® Existing Home Sales data series; estimates prepared for The Wall Street Journal by LPS Applied Analytics, WSJ, 9/23/09 14
  15. 15. Defaults Are Massively OutpacingLiquidations, So the InventoryOverhang Continues to Worsen First time defaults LiquidationsNote: This data is based on approximately 28 million loans. Total first-time defaults are running at 300,000/month.Source: First American CoreLogic Loan-Level Servicing Data, Amherst Securities. 15
  16. 16. The Current “Housing Overhang” Is 7 Million Homes –Which Doesn’t Include Any New Defaults, Which AreRunning at Approximately 300,000/Month! Source: Mortgage Bankers Association, Loan Performance, Amherst Securities. 16
  17. 17. Outlook for Housing Prices
  18. 18. Home Prices Were in an UnprecedentedFreefall Until A Slight Bounce in Q209 220 S&P/Case-Shiller U.S. National Home Price Index S&P/Case-Shiller 20-City Composite OFHEO Purchase-Only Index 200 NAR Median Sales Price of Existing Homes 180 160 140 120 100 00 00 Q 01 Q 01 Q 02 Q 02 Q 03 Q 03 Q 04 Q 04 Q 05 Q 05 Q 06 Q 06 Q 07 Q 07 Q 08 Q 08 09 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 1 3 1 3 1 3 1 3 1 3 1 3 1 3 1 3 1 3 1 Q Q QSources: Standard & Poor’s, OFHEO Purchase-Only Index, NATIONAL ASSOCIATION OF REALTORS® Existing Home Sales data series. 18
  19. 19. Home Prices Look Affordable Due to PriceDeclines and Ultra-Low Interest Rates 800 CASE SHILLER USA (1975 = 100) Modeled Home Prices - Interest Only 700 Modeled Home Prices - 30yr Fully Amortizing 600 500 Index Value 400 300 200 100 0 Date S C Shill B fL b St ti ti Bl b A h tS itiSource: Case-Shiller, Bureau of Labor Statistics, Amherst Securities. 19
  20. 20. Another Wave of Resetting Loans Is On the HorizonThe Last Wave Was Driven By Subprime Loans;This Time, It Will be Option ARMs Option ARM Alt A Prime Subprime 20 We are Total Loan Balance ($Bil) here 15 10 5 0 Source: Loan Performance, Amherst Securities. 20
  21. 21. Banks Are Selling Their REO, ButForeclosures Have Plunged By More ThanHalf, Ballooning the Inventory Pipeline 25% Monthly Roll Rates Non-Performing to Foreclosure 20% REO to Liquidation Monthly Roll Rates (%) 15% 10% 5% Foreclosure to REO Inventory Pipeline 0% 1,400,000 1,200,000 90 Days & Foreclosure 1,000,000 Non Performing to Foreclosure Foreclosure to REO REO to Liquidation 800,000 600,000 400,000 REO 200,000 0 REO 90 Days PLUS ForeclosureSource: Loan Performance, Amherst Securities. 21
  22. 22. One Third of All New Single Family HomeSales Are Financed With FHA or VA Loans Number of FHA Loans Insured FHA/VA Share of New SF Home Sales 40% 35% 30% 25% 20% 15% 10% 5% 0% 19 1 19 1 19 1 19 1 19 1 19 1 19 1 19 1 19 1 19 1 19 1 20 1 20 1 20 1 20 1 20 1 20 1 20 1 20 1 20 1 20 1 1 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 19Source: HUD/FHA, through August 31, 2009, NY Times, 10/8/09; Commerce Department through Q3 09. 22
  23. 23. FHA’s Loan Book Is a Rapidly Growing Disaster17.9% of Loans Are in Some Stage of Default;For 2007 Loans, It’s 32.4% Source: HUD/FHA, through August 31, 2009, NY Times, 10/8/09. 23
  24. 24. Existing Home Sales Are Highly Seasonal Source: National Association of Realtors. 24
  25. 25. Existing Home Sales Are Highly Seasonal HPA Seasonality Coefficient -- Deviation From Mean Source: National Association of Realtors. 25
  26. 26. Home Prices Increased Every MonthFrom May-September… Sequential Home Prices March 2005-September 2009 2.0% 1.5% 1.0% 0.5% September 2009: 0.0% -0.5% -1.0% -1.5% -2.0% -2.5% -3.0% -3.5%Source: S&P Case-Shiller 20-city index. 26
  27. 27. …But They Always Bounce in the Springand Summer! Sequential Home Prices February 2000-September 2009 3.0% 2.0% 1.0% 0.0% -1.0% Red circles represent April - June each year -2.0% -3.0% -4.0%Source: S&P Case-Shiller 20-city index. 27
  28. 28. Current Economic Situation
  29. 29. There Have More Than 8 Million Jobs Lost So Far in ThisRecession, Though the Monthly Rate of Losses Has Easedin Recent Months to Only -11,000 in November 150,000 jobs/month are required to absorb 600 new entrants to the workforce and prevent unemployment from rising 400 Change in Nonfarm Payroll Employment (000s) 200 0 -200 -400 -600 There have been job -800 losses every month since December 2007 -1000 Source: Bureau of Labor Statistics. 29
  30. 30. The Unemployment Rate Continues to Rise,Reaching 10.0% in November, Though This isDown from 10.2% in October If part-time and discouraged workers are factored in, the unemployment rate would have been 17.2% in November. The labor force participation rate was 65.0%, the lowest in 22 years. Finally, the average work week is 33.2 hours. While this is up from 33.0 hours in October, to return to the average of 33.8 hours would be the equivalent of more than two million new jobs not created. 11% 10% 9% Unemployment Rate 8% 7% 6% 5% 4% 3% Source: Bureau of Labor Statistics. 30
  31. 31. Chronic Unemployment Is Skyrocketing 38.3%Source: Labor Department, WSJ, 10/3/09. 31
  32. 32. 5.3% of All Jobs Have Disappeared, WorseThan Any Recession Since the Great Depression 1948 1953 1958 1960 1969 1974 1980 1981 1990 2001 2007 -0.5% -1.5% -2.5% -3.5% -4.5% 2007- -5.5% 0 6 12 18 24 30 36 42 48 Months after pre-recession peakSource: Bureau of Labor Statistics. 32
  33. 33. Consumer Confidence Has ReboundedSomewhat But Remains Low 160 140 120 Consumer Confidence Index 100 80 60 40 20 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009Note: 1985=100. Source: The Conference Board (www.pollingreport.com/consumer.htm) 33
  34. 34. Mortgage Equity Withdrawals of Roughly $400Billion Annually During the Peak Bubble YearsFueled Unsustainable Consumer Spending Source: www.calculatedriskblog.com/2009/05/mew-consumption-and-personal-saving.html. 34
  35. 35. Many Borrowers Used Cash from Refinancings(Cash-Out Refis) and HELOCs to Buy New Cars • As home prices have declined and other funding sources have dried up, millions of consumers have maxed out on home equity debt. • In hot markets like California and Florida, a significant percentage of all consumers tapped into the value of their homes to help finance their new cars, according to CNW Marketing Research. • Clearly this dynamic does not bode well for HELOC recovery rates or new car sales. Source: New York Times 5/27/2008. 35
  36. 36. Total Consumer Credit Is Falling Sharply Total Amount of Revolving and Nonrevolving Total Consumer Credit Outstanding Consumer Credit Outstanding (Change From Year Earlier) Down $119 billion or 4.6% from its peak in 7/08. Down $12 billion in August, a 5.8% seasonally adjusted annual rate, the seventh straight month of declines, the longest stretch since 1991.Source: Federal Reserve Board, WSJ, 10/9/09. 36
  37. 37. The U.S. Savings Rate Hit a 15-Year High of 6.9%in May, but Fell to 3.0% in AugustThis is good news in the long run, but could be a severe economic headwind inthe short run, given that consumer spending is 2/3 of GDP Peaked Source: Paul Kedrosky’s blog, 6/26/09; http://paul.kedrosky.com/archives/2009/06/the_black_swan.html; www.bea.gov/newsreleases/national/pi/2009/pi0709.htm. 37
  38. 38. Household Liabilities as a Percentage ofDisposable Income Remains Very High Peak: 138% 2000: 101% 1991: 90% Peaked Today: 122% Source: U.S. Federal Reserve, WSJ, 10/13/09, 12/8/09. 38
  39. 39. Where We Are Finding OpportunitiesSeven Months Ago, We Were Playing Offense; Now We’re PlayingDefense, As We Trim Our Longs, Add to Our Shorts and ShiftOur Longs Toward Large, Dominant, Cash-Rich Companies• Blue-chips. The stocks of some of the greatest businesses, with strong balance sheets and dominant competitive positions, are trading at their cheapest levels in years – due primarily to the overall market decline and weak economic conditions rather than any company-specific issues. In this category, we’d put Wal-Mart (which we own), Coca-Cola, McDonald’s, Altria, ExxonMobil, and Johnson & Johnson.• Out of favor blue-chips. For somewhat more adventurous investors looking to buy great companies in the most out-of-favor sectors such as financials, retailers and healthcare, we own Berkshire Hathaway, Wells Fargo, American Express, Target and Pfizer. We also own Microsoft and Yahoo!. All are great businesses, but their stocks have suffered mightily thanks to the economic downturn. We think they’re good bets to rebound when things stabilize.• Balance sheet plays. For investors who are comfortable with lower-quality businesses but want downside protection, there are many companies trading near or even below net cash on the balance sheet. Examples in our portfolio include digital media equipment company EchoStar Corp. and clothing retailer dELiA*s. Berkshire is the best of both worlds: a premier company but also a balance sheet play.• Turnarounds. There are countless companies that have gotten clobbered by the economic downturn and are reporting dismal results – with stock prices to match. Investors in those that survive and return to anything close to former levels of profitability will be well rewarded – but picking these stocks isn’t easy. Among our holdings in this category are Wendy’s restaurants, Winn-Dixie supermarkets, Huntsman, a specialty chemical maker, Crosstex, a pipeline company, and Resource America, a specialty finance company.• Special situations. This is somewhat of a catch-all category that, for us, includes Contango Oil & Gas, a stock that’s declined due to an aborted attempt to sell the company and the sharp drop in the price of natural gas.• Mispriced options. Every once in a while we take a tiny position in a highly speculative situation – often where the stock price is below $1 – in which there’s a real chance that the outcome is zero, but also a decent chance, in our opinion, of making many multiples of our money. On an expected value basis, therefore, a small portfolio of such investments is attractive. Our holdings include a number of stocks and warrants of Special Purpose Acquisition Companies (SPACs), General Growth Properties, TravelCenters of America, Ambassadors International, Borders Group and PhotoChannel Networks. 39
  40. 40. Investment Idea #1 Short the Homebuilders Via theiShares Dow Jones US Home Construction ETF (ITB)
  41. 41. Housing Starts, Completions and SalesAre At or Near All-Time Lows 2000 Starts Completions 1800 New Homes Sold Seasonally Adjusted Annual Rate (000s) 1600 1400 A slight 1200 rebound in 1000 starts and sales in 800 recent months 600 400 200 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009Source: Commerce Department, data through 9/09. 41
  42. 42. Ja Median Age (months) n- 9 2 4 6 8 10 12 14 Ja 0 n- 9 Ja 1 n- 9 Source: Census Bureau, through 8/09. Ja 2 n- 9 Ja 3 n- 9 Ja 4 n- 9 Ja 5 n- 9 Ja 6 n- 9 Ja 7 n- 9 Ja 8 n- 9 Ja 9 n- 0 Ja 0 n- 0 Ja 1 n- 0 Ja 2 n- 0 Ja 3 n- 0 Ja 4 n- 0 Ja 5 n- 0 Ja 6 The Average New Home Has Been on the Market for 12.9 Months n- 0 Ja 7 n- 0 There Is an Enormous Inventory Glut of New Homes Ja 8 n- 0942
  43. 43. Vacant Housing Stock Creates anEnormous Inventory Overhang 1.1-1.5 million excess units, equal to 2-3 years of existing home sales Source: Census BureauSource: Census Bureau, Moody’s Economy.com. 43
  44. 44. Nearly 6% of Homes Built This DecadeAre Vacant Vacancy Rate By Date of Construction 5.9% 2.0% March 2000 or earlier April 2000 to present Source: Census BureauSource: Census Bureau, through Q4 2008. 44
  45. 45. Unlike Past Housing Downturns, New Home SalesHave Fallen Far More Than Existing Home Sales A slight rebound New homes from March- sales fell 76% August from the peak; still down 69% through August Source: National Assoc. of Realtors (existing sales) and Census Bureau (new sales), both via Haver Analytics; chart from the New York Times, 6/27/09; manually updated through 8/09. 45
  46. 46. Debt-to-Equity Ratio ofMajor Homebuilders 1.97 6.76 2.0 1.5 1.40 0.99 1.0 0.59 0.64 0.53 0.55 0.48 0.5 0.26 0.17 0.00 0.00 0.0 -0.5 -11.98 NVR MDC TOL RYL MTH DHI LEN MHO PHM BHS KBH SPF BZH HOV Source: Census BureauSource: Company filings. 46
  47. 47. Inventory-to-Equity Ratio ofMajor Homebuilders 4.0 8.74 3.5 3.37 3.12 3.0 2.5 2.10 2.0 1.80 1.71 1.50 1.56 1.55 1.46 1.5 1.33 1.0 0.50 0.5 0.30 0.0 -0.5 NVR MDC TOL RYL MTH DHI LEN MHO PHM BHS KBH SPF BZH HOV -12.89 Source: Census BureauSource: Company filings. 47
  48. 48. Price-to-Book Ratio ofMajor Homebuilders 3.0 2.69 2.43 2.5 1.97 2.0 1.76 1.62 1.55 1.5 1.41 1.37 1.21 1.27 1.08 1.0 0.70 0.5 0.39 0.0 -0.5 NVR MDC TOL RYL MTH DHI LEN MHO PHM BHS KBH SPF BZH HOV -3.09 Source: Census BureauSource: Company filings. 48
  49. 49. Investment Idea #2 Iridium (IRDM)
  50. 50. Overview • Iridium is the world’s only communication provider with the ability to provide real-time voice and data communications over 100% of the earth’s service by virtue of the company’s 66-satellite low-earth orbit (LEO) constellation. In addition, Iridium is one of the few satellite operators with the ability to provide effective voice, machine-to-machine (M2M), and high-speed data services. • One of two major players in Global Satellite Communications industry • Single subscriber device works worldwide • Motorola spent $5 billion launching satellites in late 1990s • Filed for bankruptcy in 1999 with only 50,000 customers due to too much debt and clunky phones that didn’t work inside buildings 50
  51. 51. Iridium Serves Many Different MarketsSource: Company presentation, 6/09. 51
  52. 52. A Highly Attractive Business• Growing market share in a growing industry• Huge barriers to entry• US Department of Defense is an anchor customer (23% of revenues in Q3 ‘09)• Very high and rapidly expanding margins• New products and applications 52
  53. 53. Iridium’s Market Share Has Grown RapidlySource: Company presentation, 9/08. 53
  54. 54. Iridium Has Shown Extraordinary Growth inSubscribers Up 16% YOY in Q3 ’09 to 359,000 subscribersSource: Company filings. 54
  55. 55. Iridium Has Shown Extraordinary Growth inRevenue and Operational EDITDA In Q3 ’09, revenue declined 4% due to weak equipment sales, but Operational EBITDA rose 28%.Source: Company filings. 55
  56. 56. Subscriber Growth Has Been Driven byCommercial and Machine-to-MachineSource: Stifel Nicolaus, company filings. 56
  57. 57. Iridium’s Stock Has Tumbled Since It BeganTrading in Late SeptemberSource: BigCharts.com. 57
  58. 58. Why Is Iridium Out of Favor? • SPAC structure – Many SPAC shareholders were just in it for the cash payout upon consummation of a deal and are now selling • Many warrant owners are shorting the stock – Iridium tried to mitigate technical issues: • Retired 30.5 million $7 warrants • Issued 16 million new shares • Repurchased15.9 million shares • Large future funding requirement for Iridium NEXT • Dismal record of early telecom satellite networks • Prior bankruptcy 58
  59. 59. Iridium Came Public Via a SPACTransaction • SPACs have very poor track records in general • But Iridium was acquired by a SPAC (Special Purpose Acquisition Company) controlled by Greenhill, a top quality private equity sponsor • The deal price was negotiated during the market meltdown last fall (deal was announced 9/23/08), then the price was reduced in April and warrant dilution was cut back in July 59
  60. 60. Iridium NEXT • Current satellite constellation will need to be replaced starting in 2014 – Backwards compatible (existing customers will not need to replace equipment) – Improved capacity and data rates • Total cost: $2.7 billion – Satellites: $1.9 billion – Launch: $0.6 billion – Other: $0.2 billion • Funding – Internally generated cash flow – Debt – Equity – Revenue offsets (hosted payloads) 60
  61. 61. Iridium’s Cap Ex Requirements Will Rise toFund Iridium Next, and Then FallSource: Stifel Nicolaus estimates. 61
  62. 62. Iridium Should Be Able to Fund Iridium NEXT FromCash Flow, Hosted Payloads and Warrant Conversion Source: Raymond James estimates. 62
  63. 63. Valuation Share price (12/7/09): $7.97 Shares outstanding: 68.2 million $7 warrants 13.5 million $11.50 warrants 14.4 million Market cap: $543 million Less cash: $94 million Enterprise value: $449 million 2009 EBITDA (E) $126-130 million EV/EBITDA: 3.6x 63
  64. 64. Iridium’s Operational EBITDA is Projectedto Double in Only Three YearsSource: Raymond James estimates. 64
  65. 65. We Expect a Mid-20% IRR on ThisInvestment for Many Years to Come Stock Price Based on EV/EBITDA Multiples Multiple 2016 2017 2018 8 $25.36 $31.20 $37.77 9 $29.05 $35.22 $42.10 10 $32.74 $39.25 $46.43 IRR Multiple 2016 2017 2018 8 21% 21% 24% 9 23% 23% 26% 10 26% 25% 28%Source: T2 Partners estimates. 65
  66. 66. Drivers of Stock Price Appreciation • Low current valuation multiple (40% discount to closest public comp, Inmarsat) • Rapid growth in earnings • Removal of legacy SPAC investors • Warrant holders finish hedging (shorting the stock) • Removal of uncertainty overhang related to future capital expenditures 66

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