This blog post is in reference to John Hempton’s post on Trex; the post points out that Trex’s operating margins are suspiciously high. I haven’t uncovered enough about Trex that would suggest to me that there is some form of egregious accounting fraud occurring. However, I can see how Trex’s margins can appear to be so high. This industry does not sell a commodity. Rather, the industry sells marketing hype and unproven technology.
Trex was one of the companies that pioneered the use of wood-plastic composites as decking material over 2 decades ago. Unfortunately, the composite materials did not live up to their fanfare and marketing hype (e.g. zero maintenance, lasts longer than wood, etc.). There have been issues with composite deck materials from virtually all manufacturers that have led to recalls, expensive warranty claims, and class action lawsuits. Some manufacturers have gone bankrupt and were not able to pay out all warranty claims, leaving homeowners holding the bag.
The current practice is for manufacturers to exclude known problems from their written warranties. These written warranties do not obligate them to stand behind their marketing hype.
(*Disclosure: No position.)
In my previous post, I explained how CXDC’s website was worse than Bill Ackman’s due diligence on Valeant. It turns out that CXDC really does use that website for their operating business; I thought that they simply setup chinaxd.net for Western investors and had another website somewhere else for the operating business.
According to CXDC’s latest 10-K, they had $237M USD in revenue for 2016. They have almost two thousand employees:
As of December 31, 2016, there were 1,960 employees, including 710 in manufacturing, 485 in R&D, 584 in management, 59 in finance, 101 in sales, purchasing and marketing and 21 in other departments.
But apparently they cannot make a fully functional website. Perhaps it is due to a stifling bureaucratic environment of middle management: more than a quarter of their employees (584) are in management.
3 years ago, I wrote about Chinese companies with poorly executed websites. Specifically, I pointed out that YONG and CXDC didn’t have great websites. (For your information: CXDC has a market cap of $235M and the borrow is about 7%.) Let’s revisit these companies.
- YONG: Back then, I took a large position in YONG put options, betting on the Yongye takeover bid failing. Unfortunately, the takeover bid did go through and I lost money. Fast forward 3 years, their websites have disappeared. Yongyeintl.com was the website aimed at investors. It went dark on or before September 14, 2014 according to archive.org, shortly after the going-private transaction. China-yongye.com was the Chinese language website. It went dark on or before February 28, 2017 – the website is currently an error page (in Chinese). So now you understand my irritation with losing money betting against YONG. While I don’t know what happened to this company, I think it’s safe to say that their website execution got worse.
- CXDC: Back then, they did not seem to have paid for their stock photography. Now, they have rectified that. However, the copy on this website is pretty awful. The copy on the top of the website (archive.org) reads: “Welcome to China 😄 Chinese website”. Those are the exact words… in English. The copy on the bottom reads: “In case of information discrepancy between the Chinese website and English website of the company, the English website shall prevail”. That’s quite the paradox- we’re welcomed to the Chinese website but apparently it is the website that will prevail in case of [sic] “information discrepancy”. On top of that, a lot of the links on the website do not work (e.g. I could not figure out how to watch their corporate video). But hey, at least they paid for their stock photography.
(Pretium has a US$1.8B market cap and the borrow is in the low single digits. I have written about this stock previously.)
Back in 2013, Strathcona resigned from the Brucejack gold project due to disagreements over what Pretium was telling investors. Graham Farquharson (Strathcona’s head honcho) was being a gentleman and allowed Pretium to disclose on their own terms (with their own PR spin). Unfortunately, Pretium instead tried to discredit Strathcona.
So, Farquharson did an interview with The Northern Miner, a trade publication. You can read the interview on the website (no paywall):
Yes, and we told them that it has an excellent chance of being a small-tonnage, high-grade mine in the Cleopatra vein, and a couple of other similar occurrences that they found in the last drilling program. If they lined all those up, there’s an excellent chance that they could have a small-tonnage, high-grade gold mine. But they will not have a mine producing 425,000 oz. a year for the next 20 years, as they have been advertising so far.
Here’s the crazy part. This is 2017 and Pretium is almost finished building that mine.
Flying cars as depicted in this cartoon series from the 60s.
Predicting the future is hard. Yet many people talk about self-driving cars as if they will become reality in a few years. Unfortunately, the current reality is that we are far away from commercialization of fully self-driving cars. Google is the closest, yet its self-driving car technology has some serious limitations:
- It requires an attentive human driver to drive safely. This largely defeats the point of a self-driving car.
- It doesn’t work if there is heavy snow or rain.
- The car only works in areas with special 3-D maps, which are currently expensive to create.
- The system can’t handle construction zones.
- Because they drive in a non-human manner, the cars get rear-ended more often than human drivers.
- There are other situations where the cars may have problems – left turns without a light and heavy traffic, potholes, pulling aside for emergency vehicles, obeying directions from a police officer, ice on the road surface, cyclists doing a track stand, etc. etc.
I find it interesting that so many people have been sucked into the idea that self-driving cars will be an imminent revolution that will disrupt our lives. Mostly, there are many people who want to believe that technology will disrupt our lives in a positive way. There is no differentiation between technologies with major technical obstacles (e.g. artificial intelligence, machine learning) and technologies with few obstacles (e.g. cloud computing, social media, smartphone apps, over-the-top video, etc.).
(Unfortunately I did not have the time to fully research this.)
Improvements in shale extraction technology and a glut of capital have basically destroyed oil and natural gas prices. While Exxon’s management is ok, the company cannot defy commodity prices. Its upstream assets aren’t worth that much anymore because they’re inherently leveraged to oil prices. But despite the dramatic decline in oil prices, Exxon’s share price remains high.
The put options are interesting to me since implied volatility is low (20-30%+) and the company is overvalued. The options are barely more expensive than SPY puts (in terms of implied volatility), except that oil prices fell by half and America’s GDP did not.
A back of the envelope calculation puts Exxon’s private market value at <$129B versus a market cap of $359B.
(*Disclosure: Long NRCIB.)
Idea type: GARP and/or share class arbitrage
Three years ago, I wrote about National Research Corporation, an obscure and illiquid company with a market cap of half a billion. Since then, the company has continued to grow (around 11-14%/year) while the share price has stayed the same. According to the 2015 10-K, EPS for class B shares was $2.52 so the GAAP P/E is around 14. However, due to this company’s unusual structure, GAAP earnings overstate the true P/E.
The arbitrage trade might also be interesting since the spread between the B and A shares should be somewhere around 1:1 to 6:1 or higher (arguably close to 6:1), but is currently 2.16:1.