Overall, my portfolio is down several percent YTD mainly due to a longshot bet on Yongye put options and mark-to-market losses on Altisource common shares.
On the short side, shorting common stock has worked incredibly well for me this year. Unfortunately, my gains were offset by losses on Yongye puts.
On the long side, I made massive bets on Kinder Morgan warrants and Altisource common stock. The former has been profitable while the latter hasn’t. Altisource has been beaten down -53% YTD and I have been adding to my position on the way down. While Altisource continues to have absurd earnings growth, its share price has fallen dramatically due to fears that regulation may hurt the company.
Altisource is my largest position as I currently have more than half my portfolio in it. I have written about the company many times on this blog. I’m not particularly bothered by the mark-to-market losses on this position. While Benjamin Lawsky has caused Ocwen and Altisource to suffer in the short term, his overzealous regulation (or extortion depending on your point of view) is somewhat of a positive in the long-term. Higher compliance costs will provide a structural advantage to the largest mortgage servicers. Altisource will benefit because mortgage servicers will have greater IT and technology needs as the industry shifts towards reducing the number of errors in mortgage servicing.
In the short term, the regulatory issues have allowed Altisource to buy back shares at attractive prices. In the short term, Altisource’s earnings growth may pause since Ocwen has not been boarding new loans (Lawsky had blocked Ocwen’s purchase of mortgage servicing rights from Wells Fargo). In the long term I expect Altisource to continue to grow its earnings at a very high rate.
I started buying shares of Ocwen, which is now one of my largest positions. I own significantly more Altisource than Ocwen because:
- Altisource has higher growth.
- Bill Erbey owns a greater percentage of Altisource than Ocwen.
- Altisource is less complicated and has less exposure to the macro environment.
Ocwen is difficult to comprehend because MSRs are very complicated. See my post on what Ocwen and Altisource do. However, I believe that Ocwen is also worth owning because it is a high quality business selling at a depressed valuation.
In the short run, regulatory issues have imposed additional costs on Ocwen. This will slightly hurt Ocwen’s ability to generate cash in the short term. In the long term, additional compliance costs will give large mortgage servicers an edge.
Going forward, I expect Ocwen to buy up MSRs. It will ‘sell’ these MSRs to Home Loan Servicing Solutions (HLSS) and act as a subservicer. This will allow Ocwen to generate very high returns on capital as the economics are somewhat similar to an asset management company. HLSS essentially pays Ocwen to be an asset manager. If there is cash left over, Ocwen will either invest the money into adjacent businesses (e.g. reverse mortgage originations) or repurchase shares. Ocwen has recently begun to step up its share repurchases.
Yongye put options
This trade was an asymmetrical longshot bet that did not pay off. If I were to continually make very large longshot bets, I would underperform the market in most years.
I had short positions in over 100 different stocks. I found the sheer volume a little overwhelming. However, I am getting better at using shortcuts (e.g. G&A spending) and spreadsheets to become more time efficient. Because of time constraints, I did not spend as much time on my shorts as I would have liked because I have been trying to become a better long investor. I believe that I am much better at finding attractive shorts than attractive longs. However, finding attractive longs should have more attractive risk/reward because short selling can be dangerous.
Excluding put options, the diagram below shows the distribution of mark-to-market returns in dollars YTD. It does not include the cost of borrowing shares, which eats up slightly less than a tenth of the profits.
My shorts generally fell into these categories:
- Oil and gas, mostly small independents.
- Chinese stocks, most of them fraudulent reverse mergers.
- Bad businesses.
- Companies that pay for stock promotion.
- Egregious scams where insiders sell stock at inflated prices.
Surprisingly, almost everything worked.
Chinese stocks were annoying this year. Some of them were taken private. Many of them because they had expensive borrows so I avoided those (e.g. WBAI). Many saw some type of short squeeze where the borrow became incredibly expensive and/or unavailable.
Shorts that didn’t work
Some of my shorts were targets of acquisitions or going private transactions (e.g. ATHL). These events generally lead to losses for the short sellers. What I think is happening is that the management teams of bad companies often understand how bad their company is. A great solution for their predicament is to find parties dumb enough to buy the entire company. I believe that this is why so many great shorts end up being acquired. While this phenomenon is frustrating, it is an expense worth paying.
Many of my put options have not performed well: YONG, POT, AMT, CONN, RH, EBIX, IMAX, and PVG.
My CHK, MHR, NQ and COH puts were profitable.
GME puts were close to break-even.
Ruger call options are a big position for me. Unfortunately, I did not correctly anticipate the boom/bust cycle in the gun market and the effect of discounting on Ruger. In Ruger’s latest quarter, retail sell-through fell an astonishing 44% year-over-year. Fifer seems to largely attribute this to extreme discounting by Ruger’s competitors. I would highly recommend that you read Ruger’s conference call transcript for his analysis.
Since my original writeup on Ruger in Nov 2013, adjusted NICS checks fell dramatically during the three quarters from Q4 2013 to Q2 2014. I did not foresee the drop in gun sales due to the unusual combination of an election and Sandy Hook in the year before.
Credit Acceptance (CACC)
I decided to sell my shares to free up margin. We are currently in the dangerous part of the lending cycle as lots of easy capital is flooding into subprime lending. Credit Acceptance has allowed the number of loans per active dealer to fall (-4.6%). The risk/reward of its loans has gone down slightly judging from the decrease in its spread (down 1.1% year-over-year according to the latest 10-Q). It has been able to offset fewer loans per dealer and slightly lower profitability by increasing the number of new dealers (+9.8%). Overall, the number of loans increased by 4.7%.
Going forward, I expect the competitive environment to become more difficult for Credit Acceptance. In the short term (the next few years), I think it will be difficult for the company to grow. In the long term, I really like management and am very bullish on this company. Currently, Ocwen and Altisource look more attractive to me because they trade at similar P/E ratios with much better growth prospects in the short term. I may buy back into Credit Acceptance if the share price dips.
Liberty Media (LMCA/K)
Fundamentally, I believe that Liberty Media continues to do well. Sirius XM and Live Nation continue to grow. Charter has almost completed its digital transition (80% complete) and may soon see its free cash flow begin to increase. While Charter has yet to demonstrate meaningful free cash flow, some of its metrics suggest improving operations. It has staunched the loss of video subscribers while growing its voice and Internet subscribers.
Some of my mistakes in analyzing Liberty were:
- I believe I overestimated the discount to NAV when I purchased my stake. My rough valuation spreadsheet on Google Drive shows that the current discount is around 10%. Note that the spreadsheet may contain errors and depends on numerous assumptions.
- I underestimated Live Nation (e.g. I thought that it had reached fair value and that Liberty would be selling it). I erroneously thought that its size was a disadvantage; I now believe that it is an advantage. Building out Live Nation’s international footprint allows the talent to perform for larger audiences. As well, scale is an advantage when it comes to selling (sponsorship) advertising. The various scale economics make Live Nation an attractive long-term investment. Management probably isn’t lying when they say that they will generate 30%+ annualized growth in adjusted operating income going forward.
My timing on my purchase and sale of Altius Minerals worked out quite well. I think that my analysis of Altius was largely correct. However, a lot of my gains should be attributed to luck. The fundamentals have clearly become much worse for Altius due to falling iron ore prices. However, the share price went in the opposite direction and I was able to sell everything at a large profit.
My bet on Kinder Morgan warrants worked out very quickly due to optimism over the KMI/KMP/KMR/EPB merger. Looking at the fundamentals, distributable cash flow growth at KMI was slightly slower than I would have liked but was still satisfactory.
Strategy going forward
My current core longs are ASPS, OCN, RGR calls, and LMCA. Because most of my portfolio is in ASPS and OCN, these two related stocks will largely determine the outcome of my portfolio. Something that I am struggling with is whether or not I should diversify.
The big advantage to diversification is that it would protect me against a terrible mistake like QXM/XING. On the other hand, the reason I am not diversifying is because ASPS seems so much more attractive than other stocks. It has everything I want in a stock:
- Wonderful economics / sustainable earnings growth. Altisource is one of the hottest growth stocks around. Going forward, it is likely that these wonderful economics will continue given that the big banks will be selling their MSRs.
- A highly skilled CEO. Bill Erbey is the most skilled CEO in the mortgage servicing space.
- Ethical management.
- Low valuation.
- Excellent capital allocation. The company buys back more shares when the share price is low.
In my short portfolio, I will remain diversified. I do not plan on blogging about 100+ short positions a year. I may continue to blog on how I quickly screen through stocks. For example, looking at a company’s G&A spending is a powerful shortcut as the companies with excessive G&A spending tend to be quite awful.