Thursday, May 27, 2010

Ira Sohn Recap

We attended the Ira Sohn conference yesterday for the Tomorrow's Children's Fund. Klarman, Tepper, Arbess, Einhorn, Ackman, Dinan, Robbins, Zell, Eisman, Jacobson, S-Ratt, Grantham, and Niall Ferguson. In summary, this was by far the most macro oriented conference we've ever seen from a bunch of largely "bottoms up" investors.

Below are two sets of notes. One from your intrepid TILB author and the other from BTIG's Mike O'Rourke. O'Rourke writes BTIG's must read "Bedtime with BTIG" every night. While we are not much for technical trading, he provides technical insights and recaps that give a concise, useful review of the day past and preview of the day ahead. In any case, here are the notes. In both cases, these are not exact transcriptions. Also, sadly TILB had to leave in the middle of S-Ratt's brutal pack of lies, causing us to miss Larry Robbins, Bill Ackman, and Seth Klarman. Fortunately for you, O'rourke didn't leave and has complete notes. O'Rourke's notes are first, our's follow.

BTIG Notes - Ira Sohn
Posted on Thu, May 27th, 2010 at 7:17 am
by Mike O'Rourke

This is a summary of ideas expressed at the 15th Annual Ira W. Sohn Investment Research Conference.
The Ira Sohn Research Conference Foundation is dedicated to the treatment and cure of pediatric cancer and other childhood diseases.
NOTE: The notes below were taken in real time, but we apologize in advance for any transcription errors. THESE ARE THE OPINIONS OF THE SPEAKERS, BTIG DOES NOT AGREE OR DISAGREE WITH ANY OF THE STATEMENTS.

Jonathon Jacobson, Highfields Capital Management
Highfields is a long term value investor. Jacobson is worried about the current investment environment. Despite all of the looming macro headwinds the biggest threat is the “Clowns & Climate in Washington D.C.” Several states are hovering on the edge of bankruptcy and we the taxpayers will wind up paying for those losses. The administration has embarked upon a process of rolling vilification of industry after industry, Health Care, financial Services, Energy, Cable, Soft Drink, etc. The perception in Washington is that if someone has done well in this country, it was done at someone else’s expense. Rather than address the issues politicians will continue to “kick the can down the road.” Fundamentals are hard to handicap when the rules are constantly changing.

Jacobson is bullish on Sallie Mae (SLM). The company is currently misunderstood by the market because it is in transition from being a lending based company to a fee based company. The key point is if Sallie Mae were strictly in a run off mode as the government ends cuts back the FFELP program (which they are not) it would be worth $15, even with a conservative 12% discount rate. It currently has a $5 Billion market capitalization and is trading 2x pre-tax, pre-provision earnings and is trading 4x pre-tax earnings. Most competitors have gone out of business or in the process of exiting the business. Jacobson believes Sallie Mae is worth somewhere between $15-$25 per share. In 2011 he is forecasting $0.80 -$1.00 in earnings power. Additionally the company is well positioned to acquire additional servicing rights as competitors exit the business. Sallie Mae is larger than the 3 other government approved student loan servicers combined. Management is acquiring stock and aligning their interests with shareholders. 87% of the balance sheet is funded to term. Credit losses peaked in Q3 2009. Main risk is regulatory, but if management believes the best move for shareholders is to liquidate the company, they will.

Sam Zell
The theme of the election was change. A major change has occurred within the American economy. One party political dominance is changing how investors will act in the future. It is an environment of survival of the fittest. Zell presented a music video that was an ode to Charles Darwin. Extinction is for those who do not adapt and evolve. The winner is the one who builds the better boat, not the one who rearranges the deck chairs. He who adapts succeeds.

Dan Arbess, Perella Weinberg Partners
The foundations of the global economy are shifting. Fiscal imbalance and sovereign risk are only symptoms of the problems that will fuels this change. The trend of deficit spending over-consumption in the west and the export driven production of the east needs to reverse. Consumption in the east must rise and the west must exercise restraint to bring a semblance of balance back. Macro squalls can wreak havoc on a portfolio, so effective hedging strategies are important. The key them Arbess proposed was “Shaking hands with China.” The way to play the theme is to be long those companies who sell China what it needs and short those who make products that the Emerging Markets can make better. Consumption is only 35% of GDP in China, half of what it is here and the Chinese save half of what they make. China alone will increase its urbanization rate from 46% to 58%, adding 210 million urban residents in 70 million households. They need a lot of stuff to urbanize 20 million people a year, and Arbess wants to be long the guys who will be selling it to them.
Arbess believes weaker currencies and weaker sovereign credits should be sold. He is bearish on the Euro and on EU sovereign debt. This is the endgame of the debt supercycle and confidence in fiat currencies will erode, as such he likes Gold. The deflationary economic environment will lead to monetary debasement. The irony today is post-Maoist China has no entitlements and needs to create some to boost domestic consumptions and the U.S. more entitlements than ever.

He likes commodities and the commodity nations in the G-20 and even Africa, both fundamentally and as a currency debasement hedge. He says own junior mining companies that own big assets close to their customers. These will often start out trading at discounts as much as 90% to their cash flow potential, and often show less downside beta than large caps.

Arbess likes Ivanhoe mines (IVN). Its vast copper and other mineral deposits in Mongolia are close to the same size as Manhattan. Noncore assets are worth half of the current market capitalization of the company. Rio Tinto is a key partner of Ivanhoe, and its presence reduces the risk for the investor. Rio recently purchased shares above the current price levels Backing out the coal business and other peripheral assets, the stock at its current price around $13 creates the copper mine at less than $2.5 billion, which is less than half of what it’s worth on an NPV basis, and a tiny fraction of inground metal value, assuming $2.50 long term copper and $1000 gold. At recent commodity prices, Arbess thinks the stock could be worth up to $30 to Rio.

Arbess also noted Solution (SOA) and Celanese (CE) as other ways to play his theme and believes both have 50% upside from current levels. Another name he likes is YUM Brands (YUM) who had 37% growth in China last year. China’s successes of the last 30 years are real and the country is fiscally strong with $2.5 Trillion in reserves and fiscal responsibility. Another play on his theme is shorting the Japanese Yen versus the Canadian Dollar. Japan is shrinking while its debt is growing, exactly the opposite of the urbanizing emerging markets. Canada, by contrast, has arguably the soundest economy in the G-7. No coincidence, they really don’t like leverage up there. And the country is rich in Shake Hands With China resources. This is the end of the buy now and pay later mentality. The global rebalancing process will be messy, but it will also be rife with opportunity.

David Tepper, Appaloosa ManagementTepper started with an anecdote about the horse “output” problem in 19th century New York City and forecast that city would be buried under horse excrement . The moral of his story was “don’t listen to the crap.” Tepper was highlighting that the world changes and evolves and people and societies adapt. Tepper noted that everyone of the “PIIGS” has instituted austerity programs, something many would not have believed would happen. He mentioned the ECB buying debt despite its conservative Bundesbank roots and the Spanish Government shutting down the largest Caja run by the Roman Catholic church. All of these things at one point seemed unthinkable, but this is society adapting to the situation.

Tepper likes the AIG-8.175% Junior Subordinated Debt. It is trading at $0.72 on the dollar giving it a current yield of 11%. Right now there is $73 Billion of capital structure below it $49 Billion in Preferred and $24 Billion in equity. He thinks those two combined are really only worth $40 Billion. He warned that this did not mean the equity is worth zero, there is some option value and a conversion of government preferred into common could distort a capital structure arbitrage if set up. Tepper says AIG has $9 Billion of EBIT and other assets worth $45 Billion.
Tepper noted there are opportunities in the CMBS market. He said what you should really care about in the CMBS market is “Can they make the coupon?” These are 10 year securities and if they can make the coupon you should ask what will the environment be in 2016? You should not be looking at today, you should be looking at the future.

Tepper still likes Bank of America (BAC). He believes normalized earnings are $2.65-$2.70 per share and has a $27 price target. He also likes Banco Santander (STD). it is one of a handful AA rated banks in the world (no major U.S. bank is as high as AA). Only 30% of the banks exposures are to Spain, it is really an Emerging Market/Global play. They will earn $1.50 and that has the potential to double. Tepper concluded noting that 2000 was the beginning of the end and that today we are at the end of the beginning.

Niall Ferguson, Harvard University
Ferguson proposed being “Long virtue.” Focusing on nations with good fiscal situations as opposed to the overly indebted Western governments. Citing Bank of International Settlements long term forecasts Ferguson highlighted Pigs “R” Us. Which means that the U.S. and the U.K. are in equally precarious fiscal situations as the “PIIGS.” Ferguson noted that 40% of U.S. Debt is short term and that type of duration leaves one open to roll risk. “U.S. Debt is a safe haven similar to the way Pearl Harbor was.” Ferguson highlighted the “good boys, ” nations with better fiscal situations. Topping the list was Norway with net debt of -140% of GDP due to the nations effective management of its oil reserves. Other good boys were Sweden, Denmark and Switzerland. The U.S. leaves itself at risk by being highly reliant upon foreign capital.

Steve Eisman, Frontpoint
Eisman’s theme was “Subprime goes to College.” After what transpired in the subprime mortgage market a few years ago, Eisman though he would never see a business with the capability to prey upon the underprivileged to those extremes again. Then he came across the For Profit Education industry. Despite only having 10% of the students these schools get 25% of the government aid. The industry is in bed with Washington due to serious lobbying efforts and the back and forth of executives from the companies to Government positions and back. Title IV loans offered by government programs comprise 90% of for profit education revenues.

ITT Educational (ESI) has higher margins than Apple (AAPL), and margins in the for profit education industry are 3-4 times those in other industries that deal with the government. For profit schools target poorer people, often leading them towards degrees that won’t get them jobs. The companies also maneuver to acquire small failing schools in order to get their accreditation. The loans the students take out for profit education have high default rates. ESI and Corinthian (COCO) often provision 50%-60% for the loans they privately offer, so the default rates overall are likely 50%. The companies in the industry are Education Management (EDMC), COCO, Apollo Group (APOL) and Washington Post (WPO). WPO, more than 100% of its EBITDA comes from for profit education. Eisman calculates there could be $300 Billion in defaults over the next 10 years. The key catalyst going forward is that the government will publish a rule for gainful employment , that threatens the companies. The government is also seeking to fix the accreditation process.

Jeremy Grantham, GMO
IN GMO’s 7 year forecast U.S. High quality names are aberrantly cheap and should provide 7.6% real return per year. In constructing a portfolio Grantham said it should be 40% U.S. Blue Chips, 20% Emerging Markets and 30% EAFE Blue chips. Grantham notes that bonds are “grotesquely” overpriced predicted to post a real return 1.7% per year. Grantham’s 3 choices or recommendations are Timber which has 7.5% forecasted real annual return. Then Grantham likes Emerging Markets which he believes will go to a premium P/E to the rest of the world. Finally he likes high quality U.S. blue chaps. They are trading at a 17% discount to fair value and 55% of earnings come from around the world.

The bedrock of Grantham’s thinking is that “Things regress to the mean.” Of the 34 bubbles GMO has identified it takes about 3.5 years for the bubble to run up and it comes back down to the trendline nearly as quickly. All bubbles reverse. Grantham believes both the U.K. and Australia are in housing bubbles. The risks to betting against bubbles are career risk and business risk. Grantham believes debt has nothing to do with growth, and debt has less influence than most think. Grantham concluded by noting the importance of the upward bias in the third year of the presidential cycle.

David Einhorn, Greenlight Capital
Einhorn’s theme was “Good news for the Grandchildren.” In essence the fiscal challenges of the United States are so severe that they will need to be dealt with before our grandchildren inherit them. Our own future is at risk. Average public sector pay is nearly double that of private sector pay. Public sector workers “Retire to rehire,” and fuel a system that is heading in the same direction as Greece. Einhorn wonders how long will the capital markets continue to let the U.S. keep borrowing. Nobody knows where the line is, not the Government nor the ratings agencies. A credible plan to avoid the debt trap is necessary. Europe is a prequel to what will happen here.

Einhorn is short the ratings agencies Moody’s (MCO) and McGraw-Hill (MHP). Credit rating agencies provide a false sense of security and are pro-cyclical. Einhorn also questioned the validity of the Government CPI data . Citing Shadowstats, Einhorn noted inflation calculated under the 1980 methodology would be 9%, as opposed to the less the 2% it is today. The lower real rates will fuel inflation and bad behavior and create bubbles. This easy policy of bubble bailouts is an unhealthy cycle.
He believe the lower real rates tempts the central bank to monetize debt. As a hedge against this Einhorn is long Gold as well as African Barrick (ABG LN) . ABG LN trades at ½ the value of its peers, 6x Ebitda and with a 10% free cash flow yield.

James Dinan, York CapitalDinan commenced by noting people adapt, markets adapt and animal spirits prevail. Dinan believes large companies are in good shape. Dinan likes Coca Cola Enterprises (CCE). The company is going through restructuring in which Coca Cola (KO) is giving CCE $10 per share and some European bottling assets in exchange for U.S. bottling assets. Dinan stated Europe is a better place than the U.S. for the bottling business, due to less competition. The deal also gives CCE the option to expand its European footprint. After the deal and receiving the $10 per share new CCE will be $15 and trade 10x earnings and 6x EBITDA. New CCE will have 20% gross upside.

Dinan’s next long idea was ING Groep (ING). ING has a global presence as a bank and insurance company. As part of the bailout the company received during the crisis the company must split its banking and insurance businesses by 2013. The company is currently trading at €6.25 which is .6x book value. Dinan believes it can go to 1x book which would make it worth €8.50-€9.20 per share. The life insurance divestiture could be used to pay back the Government bailout, or it could spin out the insurance business. An 8x-10x P/E multiple on the combined bank and insurance company would make it worth €14-€18.

Dinan also sees opportunity in post bankruptcy equities. Currently one he is investing in is Lyondell (LALLF). Currently the stock is trading below its reorganization plan value. Q1 earnings tracked well ahead of expectations especially in the companies commodity business. A sum of the parts valuation gives Dinan a $22-$28 price target.

Steve Rattner
The former advisor to Treasury on the Auto industry restructuring provided a defense for the Obama Administration’s handling of TARP, the Stimulus (EESA), the Stress Test (SCAP) and the Auto rescue. Rattner said the Administration sought the middle ground on most issues and gave examples of the extreme views in each case.
Regarding the Auto industry restructuring Rattner addressed the question of whether the UAW received more than it deserved. Rattner said that Labor was a critical creditor and all stakeholders received more than they would have in an outright liquidation. Rattner noted that in the Chrysler plan the UAW’s VEBA received 40%-50% of what they were owed. In the GM plan VEBA received 84%-92% of what it was owed. In both cases warranty holders, dealers and trade/suppliers all received 100 cents on the dollar. Rattner used this as an example that the plans sought to protect as much franchise value as possible.

Rattner offered what to expect from the Administration going forward. He said the government will remain involved in the Financial sector. He noted taxes are going up. The Administration has avoided protectionism and is leaving business in the industrial and manufacturing sector alone.

Larry Robbins, Glenview Capital Management
Robbins started asking the question of why is the market’s P/E so low. The 3 potential explanations he offered were the “E” is wrong and estimates could be too high, or “the bigger the D.C. the smaller the P/E.”The last reason and one he highlighted was that it is not a math problem, but it is a psychology problem. He note market participants are suffering from Post Traumatic Stress Disorder.
Robbins noted that individual stocks were one of the best ways to tackle an uncertain environment. He looks for stable earnings growth, potential for multiple expansion and positive optionality. Robbins likes McKesson (MCK). He notes earnings are growing at 18% and it is trading under 11x forward earnings. The company proved it is acyclical by posting growth in Q1 2009. Robbins highlighted he expects MCK to have $5.2 Billion of “Dry Powder.” This is a combination of cash and Free Cash Flow expected to be thrown off over the next 18 months. Robbins also likes Express Scripts (ESRX). Earnings are growing 35% and although that won’t be sustainable it will still continue fast growth. Management has been superior over the past decade in retiring stock. The company is trading 14x 2011 earnings and under 13x Free Cash Flow. Robbins next pick was Life Technologies (LIFE) which is in a consolidating and over capitalized industry. The company has a 80% consumable product mix and is trading 11.5x 2011 earnings. Robbins last pick was Fidelity National Information. The company rebuffed private equity takeover attempt because the price was not high enough and figured they could do the same thing Private Equity planned by doing a leveraged recapitalization. The company is tendering to buy $2.5 Billion of shares , or 22% of the outstanding. Robbins thinks they could have done $3.5 Billion but were being conservative. Earnings grow this 15%-23% and the company is trading under 12x 2011 and 10x Free Cash Flow.

Bill Ackman, Pershing Square
Ackman started by outlining how he believed the credit ratings business should be reformed. The short version is NRSRO’s should not be allowed to rate an issue until 60 days after it comes. That would create a buyside environment that would attempt to handicap what the rating should be using market forces. The underwriter would also need the instrument to hold up in the secondary market and therefore is incentivized to make sure it is a quality product. All relevant information should be disclosed to the market and the ratings agency should disclose its model.
From there Ackman went into GGP part two. GGP will be split into two companies GGP and GGO. GGP will have 200 regional malls. It will have a competitive advantage because 80% of the properties will be single property non-recourse financing . Company owns 31% of Aliansce (ALSC3 BZ) in Brazil. GGP is benefitting from the economic recovery. GGO is where GGP’s noncore assets will go. They include housing development land, land in Hawaii, land on the Las Vegas strip and South Street Seaport. Ackman referred to GGO, that he hopes it to be a mini Berkshire Hathaway. Ackman thinks new GGP will be worth $15 and new GGO will be worth $5. He finished by saying he bought 150 million Citigroup shares but did not give his thesis.

Seth Klarman, Baupost Group
Klarman delivered what would be his opening statement if ever called before Congress. Klarman noted that most people on Wall Street operate honestly, ethically and provide good service. It is the land of caveat emptor and transactions should be entered skeptically. When it comes to the complexity of derivatives, the purchaser should know they will wind up overpaying. There is a culture of compliance. He guides his firm with two rules. The Wall Street Journal Rule, don’t do anything you would not be willing to read about in the WSJ the next day. The second is the football field rule, if run to close to the sideline you increase the risk of running out of bounds, instead cut to the middle. Financial Transactions among consenting adults are an important part of the capitalist system. He has a fiduciary obligation to his clients, not his counterparties. Short sellers are the policemen of the financial markets.

TILB Notes - Ira Sohn - these are in reverse order because we were emailing them one by one and I'm too lazy to cut and paste to reorder them.

Steve Rattner - ex Quadrangle, Treasury Car Czar, Lazard.

Reflections on crisis. Necessary and appropriate response to crisis. TARP was critically important. Stimulus package - not perfect but good. Stress Test for banks - restored confidence. Auto rescues (detail to come).

Believes Administration deserves credit for finding the middle ground.

Autos: no private capital available. Would have been chpt 9, not chpt 11. Labor was a critical creditor to these companies. Nothing abnormal about different stakeholders getting different recoveries. Believes every creditor received more than they would have in a liquidation. Doesn't believe they abrogated or changed law.

Put $50B into GM and believe it's investment worth $40B today on paper. Deems that 20% loss a success. [TILB: Conveniently left Chrysler out of that analysis]

I can't stand listening to him any further. No more notes on S-Ratt.

Jamie Dinon - York Capital
Don't think end is near. People adapt, societies adapt, etc. Equities are a good place to be if you're worried about that. Flexible, long duration, inflation resistant (albeit perhaps lagged).

Event driven:
CCE (Coke Bottling) - KO buying domestic bottling assets for $10/share. Left with European assets plus KO's Swedish and Norwegian bottlers. European macro for KO better than US - faster growing due to low penetration, better comptttv position vis a vie Pepsi and other bottling competitio, option to buy KO's Germany business as well as potential for other European assets. 6x EBITDA and <10x earnings for the stub. Comps trade at 8x ebitda and 13-15x. Stub at $15 vs comps implied $20-25. Dual listing catalyst. Safe business.

ING - Netherlands global bank. (All numbers in euro). Had Alt-A problems in crisis. Received Dutch bailout. Forced by EU to split insurance from banking. Sum of Parts: insurance - 30% in developed Europe (assume 0.7x bk in developed markets and 1-2x bk in EM, so overall 1x bk assume). Backing out insurance, €9.30 tangible book for bank. Trades today at €6. Deserves better than book, decent bank. Decent banks should trade > book.

Like post-bk equities. "Resurgence" phase.
Lyondell-Basel - ticker: LALLF came out of bk in April. $9.5B mrkt cap. Below plant value and below rejected bid from Reliance. Bk plan calls for 1.8B ebitda in 2010. Did $0.6B in Q1. Specialities business is rock solid and does 1B ebitda like clockwork and was on track in Q1. So the non-specialty business is crushing it if you back into the projections for that business. Apollo is biggest owner. Sum of Parts is $18-22B. Normalized ebitda $3.5B. Put 5-6x multiple on that and big upside.

Liquidation Play: Icelandic bank Keupthenk (spelling sorry). Claims trade at 23c. 25% Yield to Recovery. Base case 39c. Downside 22c. Upside mid 50s. 7th largest bk in history. 27% market price in cash. Most of the balance is performing loans.

David Einhorn: Greenlight
Title "Good News for the Grandchildren" [referring to passing budget debts to grandkids]

Obama knows what he wants to do on every issue in advance, but he wants to start a blue ribbon commission for dealing with debt w/o promising to actually do anything about it.

This won't be our grandchildrens' problem - it will be our generation's problem. The mount of debt is mind-numbing. Gov't acctng is done on a cash basis, so future promises (unfunded mandates/entitlements) aren't even counted yet.

Rails on average public sector worker situation vs private sector. Ridiculous skew of compensation and job security. Amount of gov't workers has now made them a critical voting block.

Questions: 1) how long will capital markets accept this? 2) how much liability can we pay via central bank monetization?

AAA financial instttns collapsed and nobody saw it coming, even as it became inevitable in retrospect. Think of the implication to gov't.

Using The Administration's 10 year forecast which assumes low rates and robust economic growth shows structural deficits through the whole period (just in time for unfunded mandate costs to kick in).

Should get rid of ratings agencies entirely or at least rid of their govt legislated position. Made fun of ratings agencies using their own quotes (especially the sovereign analysts).

Procyclical ratings agencies will cause problems at the worst moment. Ill-timed (from borrower's perspective) downgrade can serve as a coup de gras.

Zero risk weighting for banks to buy gov't debt will massively exacerbate the problem. Practically ensures the problem will spread fast.

Greenlight still short Moody's and McGraw Hill (S+P).

Monetization likely. May even show up in gov't statistics (sarcastically delivered). Recent bout of of QE not showing CPI ramp may have provided central bankers false confidence.

Shadow Stats says pre-1980 methodology would show 9% CPI today vs 2% govt reported. Lots of other stats on bad govt CPI stats.

[Summary from TILB so far - buy gold]

Low rates drives "wealth effect" by driving up capital market asset prices. This is fake.

Failed banks balance sheets most recent financial statements show solvency despite the huge losses fdic takes upon failure. This is almost certainly also true in "solvent" banks. Easy money policy used to bail them out.

Low rates creating an addiction. Japan can't even accept normalization.

If the emergency has passed, why still have 0% rate emergency policy? Negative consequences in addition to debasement/inflation: bubble inflation [malinvestment risk]. Rips Bernanke, etc.

Fed seems to want to create a new bubble. [Goes through history of Greenspan's bubble machine and into Bernanke's sov debt bubble...]

Gold, African Barrick Gold (ABG). ABG trades at half value on nearly every metric (6x ebitda). Believe catalysts include major index inclusion.

Patrick Wolfe (the guy that plays five people blindfolded simultaneously in chess at Berkshire). Announced the new Ira Sohn San Francisco Excellence in Investing in the Fall. Will be an annual event.

Next up, Einhorn

Jeremy Grantham - GMO
Got out of intense company analysis 20 years ago and into the bullshitting business. So here I am.

7 year forecast updated through May 21. S+P 1.5% pa real, high quality is "aborrently" cheap. Small cap expected return negative. [Long quality/short small crap anyone?]

Bonds grotesquely overpriced. EM 6.1% pa.

Timber is his top pick at 6% real. Didn't lose money through great depression. EM is his second place pick. US quality third. Combination "would make quite an interesting portfolio, I think".

US large high quality at cheapest value ever. "And right when we need them!"

Bubbles always make it back to trend. When you see one, it's time to cash in on some of your Career Risk chips. Avg bubble take 3.5 years to form and slightly faster to return to trends.

Took some time to taunt French and Fama. Made fun of Bernanke.

When you find a bubble, fighting it is incredible pain.

Today's bubble? UK Housing bubble is incredibly massive being supported by variable rate financing (Aussie too). UK housing needs to fall nationwide in price by 33%. Aussie needs to fall 42% to trend.

[TILB - Overall, one of most entertaining speakers]

Steve Eisman - Frontpoint
Subprime Goes to College (for profit education shorting)

Basic short thesis on for profit education. Bad companies, gov't in bed with for profit education, nasty selling habits, etc.

Often gov't grants/loans are 90% of revenue. ITT - 40% op mrgn vs 7-12% for typical gov't contractors. Title 4 has accntd for more than 100% of rev growth. Same for Apollo (growth more than 100% from gov't).
Historically, lower means families seek lower cost instttns. Title 4 inverts this needed relationship - hence the subprime analogy.

Further, the industry doesn't successfully educate their students (on average). Calls out CoCo, Apollo and ESI (ITT). Drop out rates 50-100% per year. Quite alarming, particulalry given student debt that accompanies this. Defaults of gov't guaranteed loans skyrocketing, despite industry obfuscation. When industry makes private loans, they provision 50-60% up front.

None of this matters until gov't cuts them off. Unregulated (loosely regulated) sales practices. Also, schools battle being cut-off by controlling accreditation process (akin to ratings agencies) to stay eligible for govt guarantee loans. BPI example shows how for-profits acquire distressed not for profit schools to get their accreditation.

Gov't looking at instituting new requirements. In particular, a Gainful Employment measurement for grads. Will crush APOL even if cut costs by 15% (40% hit to profit in two years), ESI 50%, COCO 40%, EDMC lose massive money due to debt, Washington Post would go from very profitable to overall loss making.

Believes if nothing is done, on the cusp of social disaster.

Niall Ferguson (Harvard).
No investment experience. Pure academic. Kept accidentally referring to David Tepper (prior speaker) as "Steve." Was an KC yesterday at a Kauffman Conference about Expeditionary Economics. Was hopeful it meant sending Paul Krugman to Somalia.

Believe we should be long "virtue". Even if PIGS cut to austere levels, still will be >100% debt to gdp. Guess what: same analysis shows worse for US and UK. PIGS R US.

Metrics of Doom. Shows cyclically adjusted primary balance: US, UK, Greece and Japan are absymal. Lots of other analysis that keeps showing US is "Out-pigging the PIGS" on all sorts of metrics. All his charts basically show is what won't happen. Problems will explode before them.

40% of US federal debt rolls in next 12 months. Treasuries are a safe haven in the same way Pearl Harbor was. Don't expect to hold a 10 year to maturity.

Shows a list of the Good Boys. Switzerland, Australia, NZ, Denmark, Czech, Australia, Canada, Sweden, Norway, etc.

Good way to diversify away from EM. Some of the same concepts but perhaps less China risk.

Don't argue with nasty fiscal arithmitic. Predicts US has Greece problem by 2012-13.

David Tepper: Appaloosa - 30%+ annualized since 1992.

Spoke at conf in 1998 to 75 people.

Was $13B of AUM last month. Now $12B. Oh well.

Wrote a song but not going to sing it.
Story from 1800s: tells story of horseshit problem that Hance also occasionally shares. Crisis from urban horse "output." Crisis happens, markets adapt, people adapt. Most likely won't be hyperinflation or deflation. The ECB bought govt bonds - the Bundesbank - "holy Christ. it's like the chastity belt is off and the girl is starting to play." The world adapts.

Investment ideas:
AIG - small insurance company (har, har). 8.175 jr sub debt. $4B issue. $24B of common equity. $12B of preferred. $9B of EBIT. Has another $40B of jr debt to his bonds which trade at 72c on dollar. So $70+B of jr securities. Maybe not worth $70B, but probably positive value. Govt owns 80% equity. Do your own work.
CMBS: started investing in late-08. Typical: 30% equity in a property (or 10 eq and 20 mezz). In the mortgage AAA 70%, jr AAAs 10% and then another 8% jr AAAs. Cap rate's not the thing. It's "can they make the payment"? No building going on. Bought an AJ the other day near 20% YTM likely to retire at par. Not looking at today, looking at future.

Equity Market: in 98, talked about Kospi and Samsung and Posco. Not bad ideas at that time period. If you want to make a lot of $ today, financials. BAC will make normalized $2.70. We say worth $27. Santandar (we know people hate it). One of 5-6 banks in world still AA. 30% Spain, majority EM, rest US. Double from here.

Thoughts on the world: thinking back to 97-98 period. History rhymes. Initial sov debt crisis. Lagged by Russia default. Then LTCM. Then Fed eased like crazy and market +50% (begining of end of bull mrkt). Maybe today is the end of the beginning. We know what our troubles are and we can attack them. Won't be that bad either way. Somewhere in the middle.

Sings a quick ditty then says, "I'm done."

Dan Arbess - Perella Weinberg Xerion (restructuring expert - (youngest partner ever at White and Case - led their restructuring group)).
Introduced his son who is a Leukemia survivor (6yrs ago). Loud applause.

Unsustainable global growth model of East lending to West for consumption of its production. World must rebalance. No quick fix. East must consume and West must save. This is bigger than 2008. Fear we and our politicians might not be up to the task. Placid macro backdrop may be gone for balance of our careers (he's probably 45). Success demands we be on the right side of global themes and hedged against dark side of those themes.

Themes we like: shake hands with China (buy what China needs). Short overleveraged Western producers. Hedge debasement (precious metals). Used an example of the West as a boiling frog.

Our nation alone owes China a trillion and a half dollars. Gov't taking over private debts through balance sheet contamination process. Every scenario bad for Euro. Bearish on Euro and Euro sov debt. US Treasuries perhaps short term safe haven, but beware. Confidence in fiat paper will erode. Gold and other precious metals. Prepare for stag-asset inflation.

We need to buy less, eat less and study more. Post Mao'ist China has no social entitlements and we have more than we can afford - it's ironic. Prepare for East to rise up and West to shrink down.

Gov't intervention growing and growing (took an explicit swipe at Rattner who is a speaker later in the day - referncing S-Ratt's pressure when Xerion led the Chrysler Holdouts [as a personal aside, hard to brlieve that was only a year ago]).

Like commodity rich nations (including Africa and jr miners).

Ivanhoe Mines ($13/sh). Owns largest undeveloped copper mine and huge met coal assets. Met coal and other non-core assets worth half market cap. Rio Tinto strategic partner that will own 47% of company. Has bought from $10-16. Down 30% this month. Believe copper mine is implied at half NPV value.

Look for good downstream businesses with big mrkt shares and EM presence. Solutia. Like it a lot.

Even further downstream - EM consumer businesses. YUM Brands. Explosive growth in China.

70% of all products sold in WMT made in China [TILB - wow]. Short high cost leveraged balance sheet G-7 producers.

Doesn't believe in China bubble. Formidable competitive advantage and resource base. True that latest stimulus is inefficient but believe urbanization trend and fiscal situation will drive them through that.

Short Yen vs CAD. Summary: Japan is totally f'd. Canada best G-7 economy.

2008 learned banks aren't safe. 2010 even sovereigns may not be. What's next? American innovation and EM globalization will drive the rest of our careers. Rebalancing will be messy and restorative. Loaded with invstmnt opps.

Sam Zell
No particular stock pitch. Here to tell you thoughts on the environment.
Post election theme of change. We have real change. No doubt. We are going to extremes that will impact investors in the future.
Every year since 1976, I've sent/issued an annual gift that has my thoughts on the next year. Here's what I sent this year:
The Survival of the Fittest (played
Extinction from inabikity to adapt. Shakes out weaker and benefits stronger. Ability to look around the corner and see what's coming. "Charlie...Charlie Darwin...sumpin' smells like fear" [autos, tbtf, swaps, etc. all addressed] "the pie got smaller, who will eat, who will be eaten". "The DNA that will endure is the DNA of the entrepreneur."

"So I guess the message, in less than subtle terms is 'he who adapts will succeed, he who doesn't adapt may not be here next year.'"

Short and to the point. Basically a video of his last music box and the song.

Jon Jacobson (Highfields) Went first because Sam Zell wasn't there yet.
20-30 core positions.
Very worried today. Primarily about the "clowns and the climate" in Washington. 50% of those filing tax returns in 2010 will not pay tax. We will be on the hook for state's liabilities. Administration that is fundamentally anti-business with a rolling antagonism and villification of business. There seems to be something wrong with earning acceptable returns and being successful. Worried about class warfare and social unrest down the road.

As excited about the discounts available today in good businesses as ever. But how do you trust the environment when the rules constantly change.

That said, talking about Sallie Mae. Good underlying biz fundamentals and we understand why it's disliked.

2x pre tax, pre provision earnings. 4x pre tax earnings.
6x net income.

Dealt with refinance concerns. Congress eliminated FFELP in the health care reform bill. Despite that loss, still #1 by far.

Worth $15-25/share. Liquidation/runoff vale $15. By 2011, $0.8 - $1 per share earnings. Potential to acquire servicing rights and improve balance sheet $0-$2+/share ($1/share of earnings power is possible). Biggest, most efficient student loan servicer. Dept of Education has SLM as one of four servicers for Fed direct student loans. Bigger than next 3 combined.

Dominates private student loans. Parents co-sign more than 80% of priv student loans.

Most effective collector of defaulted loans. Biggest mngr of 529 plans.

As FFELP goes away, many smaller student lenders will need to shed servicing as they lose scale. SLM well positioned to buy them.

Mgmt totally aligned. Love mgmt. Co. has retired $6B of unsecured debt at attractive prices in last 12 months. CEO buying with his own money, etc.
87% of balance sheet is term funded. Can easily retire maturities as needed. Appropriately capitalized.

SLM legislation risk. Hard to assess. Every company under attack.
Bank Tax risk. Bankruptcy reform. CFPA could become a regulator. Believe mgmt would literally liquidate if that's the best value per share opportunity.