- My thesis was that ESRX would grow its profits. In the last quarter it did not. Something is wrong and I don’t understand what it is.
- I goofed because I don’t understand the implications of Obamacare as well as I should. I can’t figure out where the macro environment for Express Scripts is headed.
- I don’t like how Express Scripts’ integration costs have supposedly gone up. It seems like they may be trying to manipulate their adjusted earnings. I really dislike that type of behaviour. Honest managers tend to be better at running businesses. Managers may fail to correct mistakes if they do not want to recognize that they made them in the first place.
In general, I know I’ve been much better at identifying bad stocks than good stocks. I definitely have room for improvement on the long side.
*Disclosure: I sold all of my ESRX calls.
When I wrote about ESRX on August 1, 2013 the stock closed at $65.56. It is currently trading at around $67.32 (+2.7%), underperforming the NASDAQ, S&P 500, and other indices. I happen to have made an overall profit on my calls because I sold ESRX shares in January when my Jan 2014 calls expired.
Here’s the press release. I am very surprised that Altius chose to do a secondary offering of shares. Management initially said that they would sell convertible debt.
In general, secondary offerings scare me. Selling shares is an extremely expensive way of raising capital:
- Share dilution from issuing shares at a discount.
- Altius’ underwriters will collect a 5% fee and a call option.
- Various professional fees in handling the paperwork. I believe this usually costs hundreds of thousands of dollars.
Secondary offerings are generally a sign that management (A) is stupid or (B) believes that the stock is overvalued. Brian Dalton has a track record of selling high and buying low so it is almost certainly the latter. Perhaps I should have noticed the overvaluation earlier; my process may have been flawed.
Here’s the idea:
- Find options or warrants where the implied volatility (according to the Black-Scholes model) is very low. I consider implied volatilities slightly above the IV of the S&P 500 index to be low. Anything under 30 is low.
- Among that universe of long-term options, find the ones with underlying businesses that are able to compound their intrinsic value at very high rates.
Compounding is very powerful over long periods of time. Options are generally a leveraged way of playing a stock. If a stock is mispriced, the options may be even more mispriced.
- Stop giving broker-dealers (and by extension, market makers) special trading advantages over institutional and retail investors. There is no reason why broker-dealers should be able to price in sub-penny increments while investors cannot. It’s bullshit.
- Tighten spreads. Historically, this has been the biggest reason why trading costs have gone down for investors. However, the SEC should be careful not to make spreads too narrow to preempt the “shaving” trading strategy. Shaving is basically a strategy where you bid one penny more (on 100 shares) to stand in front of the line. It currently exists as market makers can jump in front of any order by bidding an additional penny on 100 shares (e.g. sub-penny front running).
- Ban retail brokerages from taking kickbacks via payment for order flow. Doing this would force retail brokerages to raise their rates to compensate for lost revenue from selling out their customers. It may put an end to the “free” trades offered by some brokers. This move might have bad optics politically but it would be the right thing to do. This move would devastate the order internalization industry, which would have no reason to exist.
- Ban exchanges from giving special trading advantages to market makers. (This stuff gets really complicated because there are so many trading advantages and because many of them are subtle.) Of course the market makers would claim that they provide “liquidity” and are performing a valuable service for the markets. They will claim that they need incentives to provide liquidity.
While the steps above won’t get rid of all the market abuses, they would dramatically reduce trading costs for investors.
The chance of this happening is almost zero. The SEC gave special trading advantages to broker-dealers. It played a role in creating the sub-penny front running game. Currently, the SEC seems like it wants to confuse and mislead the investing public. You can read their Twitter feed and the articles on their website (e.g. “research” that totally misses the point and this speech where a staff member pretends that complexity is a good thing).
In the past, I would blindly assume that regulators are the “good guys”. Nowadays, I am disappointed in myself for being naive. The reality is that the human beings who work at the SEC sometimes do the right thing and sometimes do not.
- Liberty will buy back shares below $135. A year ago, Liberty was buying back shares below $135. Since then, Liberty’s stock portfolio has gone up in value. SIRI is mostly flat while CHTR, LYV, and BKS have gone up.
- Liberty will continue selling its Barnes and Noble shares since (A) the share price is rather high and (B) it looks like the Nook will die. Both Liberty and Leonard Riggio (founder and major shareholder) have been selling.
- If Liberty sell shares to pay for share repurchases, Live Nation shares will be the first to go after Barnes and Noble. I think that Live Nation is largely mature and will not grow as fast as Sirius XM or Charter. Management strikes me as slightly promotional. Their metrics (e.g. adjusted operating income) consider their IT investments as growth capex rather than maintenance capex. In my opinion, their business is one where they have to keep running just to stay in place. Adding new features simply maintains their competitiveness rather than growing market share. Lastly, Live Nation shares have gone 62% in the past year.
- Both Sirius XM and Charter will continue to grow their free cash flow at high rates in the next few years (at least 10%).
The reason I am putting my predictions down is to test my investment thesis. If my predictions don’t pan out, then I will need to reconsider my position in Liberty.
I have recently sold some of my Altius Minerals shares (Altius is not buying back its shares) to buy more LMCA shares (LMCA should be buying back more shares). Liberty’s current assets consist mainly of wonderful companies (Sirius XM and Charter) alongside a mismash of other random assets (LYV, BKS, True Position, Atlanta Braves, a potential lawsuit windfall, cash, and a very large interest free loan from the IRS in the form of deferred taxes). It is essentially a wonderful company trading at a small discount to its assets.
Restoration Hardware is a retailer with a shrinking store count, going from 95 stores in YE2010 to 70 stores in YE2014. Despite this drop in store count, capital expenditures have grown from $2.024M to $93.868M in that timeframe. One explanation is that Restoration Hardware is improperly capitalizing expenses to inflate its earnings. Of course, it is also possible that there is no accounting fraud here. Perhaps Restoration Hardware is legitimately making a huge investment in software and store renovations. As always, you should do your own due diligence and come to your own conclusions.
Market cap: $2.6B
Shares short / shares outstanding: 10.3% (Shares short as a % of float would be higher)