Year in review 2014

In 2013, Altisource was the best performing long position in my portfolio.  In 2014, I unfortunately made it the largest position in my portfolio.  Because of that, I am badly lagging the market.

Altisource

I first wrote about Altisource on January 10, 2013.  That day it closed at $93.57.  Today Altisource is trading at around $34.  The stock has fallen by almost two thirds.  What has happened since Jan 2013?

The good:

  1. Earnings grew by 59%.  YE2012 EPS was $4.43.  Current TTM EPS is $7.06.  If you adjust for amortization of intangible assets, EPS growth would be higher.

The bad:

  1. Ocwen entered into a consent order with the NY DFS.  This will slow the growth of delinquent mortgages at Ocwen and in turn slow down Altisource’s growth.  (Ocwen’s delinquent mortgages currently account for most of Altisource’s profits.)
  2. Regulation should slightly increase Altisource’s compliance and legal costs.  The NY DFS consent order may reduce the fees that Ocwen pays to Altisource if the fees are unreasonable or above market pricing.
  3. Bill Erbey has been forced out of his companies.  He is no longer the chairman of Altisource.
  4. Altisource announced that it would take an earnings hit from exiting its lender placed insurance brokerage business.  I’m of the opinion that this hurts Ocwen more than Altisource over the long run.
  5. Lower defaults due to higher home prices and low unemployment will reduce Altisource’s profits from default-related services.

Maybe I’m crazy but I don’t think that it’s the end of the world for Altisource.  I think that Altisource will continue to grow at a slower rate and that it deserves to trade at a multiple of at least 15-20+.  ASPS currently trades at a multiple of around 4 if you adjust for amortization of intangible assets and normalize earnings.

I don’t think that Ocwen/Altisource’s regulatory woes will get worse.  In 2014, Ocwen was not able to make any meaningful MSR purchases.  For things to get worse, Ocwen would have to sell MSRs.  The NY DFS did not make Ocwen do this.  The consent order allows for Ocwen to buy more MSRs as long as it meets certain servicing transfer benchmarks (which are yet to be determined).  Going forward, it seems likely that Ocwen will be able to eventually buy MSRs again, grow its MSR portfolio, and in turn grow Altisource’s revenues.

If Altisource had its own Deepwater Horizon disaster or instead murdered dialysis patients by overdosing them on EPO, perhaps its share price would have fallen less.  What are the company’s sins exactly?  Ocwen and Altisource did a fairly good job of giving away billions of dollars to ordinary Americans in the form of loan modifications, short sales, deed in lieu of foreclosure, etc. etc.  Its loan modification rates are fairly high.  But apparently it could have done an even better job at giving away free money and in helping homeowners obtain free money from the US government (e.g. HAMP, HARP, etc.).  So if you are a New Yorker who borrowed irresponsibly and took on a mortgage you could not afford, you will receive $10,000 since Ocwen did not give you free money.  America is a strange place.

Let’s see how Altisource’s fundamentals work out.  If Altisource’s recurring earnings collapse, then it will be clear that I screwed up.  And if I’m right, Altisource will grow its earnings and its stock will go up a lot.  I will be holding onto my shares.

Short selling

I did a pretty good job at identifying flawed stocks.  Unfortunately, what I made from shorting common stock was offset by my losses on put options.  That is because I took a massive short position in YONG that did not work out in my favour.

Shorting stocks for silly reasons

Sometimes I short stocks for emotional reasons.  There are certain stocks that I want to short because I want to feel a sense of justice.  Pretium is a short that I hung onto for emotional reasons.  I detest their CEO for smearing the few honest people remaining in the junior mining industry.  But… Pretium’s deposit might actually turn into a mine and there is some value there.  It is more rational to short other mining stocks with far more uneconomic deposits.

I would take pleasure in shorting Globalstar because I think that the folks at Maglan Capital are charlatans.  Their Twitter account suggested that others should put their GSAT shares into a cash account.  Doing so could lead to buy-ins for short sellers, leading to forced buying that would drive the GSAT share price higher.  If I were to take a position in GSAT, I would expose myself to the risk of such a buy-in.  Stated differently: Maglan Capital may be trying to encourage others to engineer forced buy-ins on GSAT.  In the perverse world of my emotional logic, this makes me want to short GSAT and potentially become one of their victims.  (If my flawed logic doesn’t make any sense to you, I don’t blame you.)

Overall, I think that there are may be better shorts than GSAT out there.  The short is less compelling than when I originally started shorting the company earlier in 2014.  Since I originally put on my position, Kerrisdale Capital started bear raiding the stock and unfairly comparing Globalstar to Sino Forest.  (The Sino Forest fraud was clearly illegal and egregious.  What Globalstar is doing does not strike me as something that should be illegal.)  Since then, GSAT’s share price has dropped and the risk/reward is not as great as what it used to be.  While it’s still a good short, the rational thing to do is to prioritize my margin for my best short ideas.  Ultimately, any short position in GSAT won’t affect my performance much because I will keep short positions in common stock very small.

Bioturds are where it’s at

Most of my short positions are in scams attached to real businesses.  Currently, the fraud industry is really pushing development-stage pharma stocks.  In 2015, it is likely that I will have a lot of pharma shorts.  I do not know when the pharma nonsense will collapse and the scumbags move onto something else.  Mining, oil & gas, and Chinese reverse mergers will have a smaller place among my shorts.

My approach to shorting bioturds

I don’t think that it is a good use of my time to try to understand pharma stocks at a high level.  Each niche is very unique and esoteric.  To understand everything would require a massive investment in time.  I find resource stocks easier to understand because the technology is similar between companies.  If you understand shale, you understand a large universe of energy stocks.  If you understand regenerative medicine / stem cells, you understand only a small subset of the pharma stocks out there (e.g. ONVO, HART).

With resource stocks, the end product is more or less a commodity.  The end markets for hydrocarbons and metals are very similar from company to company.  With pharma stocks, each end market is different.  For each drug, you have to understand the size of the market, drug substitution, other promising drugs that might become competitors, the behaviour of insurance companies, future government reimbursement, etc. etc.

My approach to shorting pharma stocks relies heavily on shortcuts and time-saving tricks:

  1. I will only look at stocks that pay for stock promotion or are otherwise connected to the fraud industry.
  2. R&D as a percentage of G&A.  I find this shortcut to be very good.
  3. Adam Feuerstein of TheStreet.com is an excellent journalist and a must-read for pharma stocks.  If I am interested in a particular pharma stock, I look at his past articles on that particular company.  His Twitter account is worth following.

Rightly or wrongly, I do not spend a lot of time researching individual pharma stocks.

EDIT (12/27/2014):  To clarify, I strongly prefer situations where the science may not matter much and the company’s flagship drug has little lottery ticket potential:

  1. The drug has obvious patent issues even if it is commercially successful.
  2. The drug has been tested before and the previous owner of the rights have given up on the drug.
  3. The rights to the drug were purchased from insiders.  (Though this does not necessarily mean that the drug is hopeless.)
  4. The drug failed phase II trials but the company is proceeding with phase III anyways.

Extreme viewpoints

I had very extreme or unconventional views on:

  1. Canada Lithium / RB Energy.  I thought that their mine would be extremely uneconomic.  That seems to be the case so far.  Originally, I thought that the company would go bankrupt.  Later, Canada Lithium announced a merger with another company that was sitting on a pile of cash.  At that point, I did not think that Canada Lithium would go bankrupt.  Well… it looks like I was wrong.  Management ended up throwing good money after bad.
  2. Yukon Nevada / Veris Gold.  The company is in bankruptcy so I was right.
  3. Yongye.  I bet against the going private transaction, which ultimately ended up closing.
  4. Restoration Hardware.  Not working out so far.  It looks like I will have a permanent loss of capital on this trade (because I bought puts that will likely expire worthless).
  5. Conn’s.  I was late to the party but it looks like I am right about this company so far.
  6. Coach’s CEO being the next Ron Johnson.  So far it looks like I am right.  However, it’s too soon to tell.
  7. Most junior resource companies being scams attached to real businesses.  It looks like I am right.  Granted, these stocks arguably collapsed because commodity prices collapsed.
  8. Alderon’s Kami mine will have all-in costs of around $120/ton (that was my back-of-the-envelope estimate).  It will not have operating costs of $42/ton (PDF press release).  It looks like I am right.  Alderon is currently in cash preservation mode.

Unfortunately, I did not make money on my extreme viewpoints despite being right on many of them.  This is mainly because I made a big bet on YONG that did not work out, wiping out my gains on my other shorts.

My bearish views on resource stocks did help me avoid the carnage in smallcap resource stocks.  Unfortunately, I don’t think that there was any way that I could have made a lot of money shorting resource stocks.

*Disclosure:  Long ASPS and OCN.  No current position in ONVO, HART, Pretium, RB Energy, Altius Minerals, or Alderon.  Short GSAT, RH via common and puts, short CONN via common and puts, short COH via puts, short Veris Gold and looking to cover.  I may trade my short positions without blogging about them.

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12 thoughts on “Year in review 2014

  1. Hi Glenn,
    I really enjoy your blog and also recommended it at my blog.
    In general I agree with you about Altisource (I also invested ) but from my previous experience you should be very careful with asset allocation into companies which encounters the regulation issues.
    The company management now depends on regulator decisions and this is not the place where you want to allocate a lot of capital.
    From my exirence (i invest more than 6 years) You can achieve very good annual returns by investing at simple companies and not taking such risks as with Altisource. I think that the maximum allocation that Altisource deserves is around 5% of portfolio.

  2. ASPS has been a great learning experience and whatever happens, I think that in the future it will be even better.

    No one can really argue that the valuation currently is extremely cheap, but I’ve been really surprised by the amount of noise and FUD that outright ignores the valuation.

    I can’t help but to think that a lot of people somehow instinctually believe (confirmation bias?) that a massive market reaction is a justified one and it makes their “hunch” right. I’ve found that the common denominator with these people is the inability to present their case with any degree of usable information. Sometimes you’ll just have to accept the fact that people love the feeling of being right, even if it’s confirmed by a market reaction and not a earnings report from a company.

    Maybe it is justified, it’s hard to say at this point and I think it will only be revealed when ASPS releases more Q-earnings. But given the history, I don’t see it impossible that the market just plainly overreacts to negative news.

    When the valuation is ridiculously low and the market is pricing the stock for a total catastrophe that seems really unlikely, I don’t really see why anyone would sell and spread FUD unless they are personally scared/hurt and are just projecting their own feelings out to the world.

    If the cash flow drops so much next year (and doesn’t seem to grow) that the current valuation is justified, I’ll probably exit with no regrets. Currently the (known) reasons why the cash-flow would or will drop are the force-placed insurance exit and regulator somehow dropping the price of which OCN buys the services.

    I personally started buying ASPS at over 100$ and the only lesson so far has been that despite low valuation (which I thoughts it was between 50-80$), investors can be so fearful that the valuation turns from really cheap to ridiculously cheap.

    Learning from the lesson, in the future I’ll probably take it a bit “slower” with companies under regulatory pressure. It might be a mistake in some cases, but in my case a big part of enjoyment of investing comes from having the ability (excess capital) to buy the sell-offs.

    I really don’t see how 2/3 drop in price could have been foreseen given the known information back then and anyone who claims otherwise either had a hunch or is full of shit. I’ve even seen some people imply that the ASPS management was foolish because they didn’t foresee it.

    I have to give it some more thought, but I believe that one lesson here can probably be found when it comes to “unknown information”. I found ASPS a bit hard to figure out especially when it came to the “source” of its earnings. Thankfully this was one of the reasons why I didn’t burn my hand with it too bad and was able add a lot to my position even during the drop to 30’s.

    Considering that, I might be even more conservative with such things in the future.

    In the end I guess there’s only so much you can do to try to predict what will happen. Knowing what I knew back then and what has happened, it still looks like a bet that I’d take any day. Today I remain really optimistic about ASPS because either I’m brain-damaged and don’t see something that the bears do or the market has seriously over-reacted and the returns are really juicy going forward.

    I hope you luck next year and years to come, Glenn.

  3. Yeah it is also interesting to note that those MSR’s will be sold in small portions. So ASPS will need to continue providing services to OCN while they service those things. So let’s say they would made like 220 million adding back amortization in 2014. But now force placed insurance is gone, that is like what, 50 million a year? That still leaves 150-170m$ in earnings next year.

    Plus they will keep the most problem loans. Plus they still added non agency MSR’s over the past few years, and that market is still almost a trillion$ large. Then there is growing non OCN revenue.

    And finally they are investing in their technology. And they are investing by paying a lot of programmers, so that is not capex. So on the tech side, the margins should go up over the next few years. So it seems extremely likely that FCF will be at the very least a 100m$, and most likely closer to 200m$, and could possibly even go higher. So I guess it seems they should at least trade at 70$ or so?

    I have a feeling I will be sorry for not buying more at these levels. But I still think it is a mistake to buy something with regulatory risk for 10x earnings. I should have waited it out for more security or for cheaper prices. Thoughts?

    • We’d all be richer with a time machine haha. I am not very good at predicting short-term price fluctuations in stocks.

      If I think something is cheap I buy it (or place a limit order and patiently buy it). I usually don’t try to time the market because I’m not good at that.

  4. Would you mind sending your blog setting so that people reading by RSS (Feedly) can see the entire article rather than just the first few words?

    • I don’t know of an easy way to do that with wordpress.com. I think wordpress.com doesn’t want webspammers to scrape the site.

      Some RSS readers other than Feedly allow for full posts.

  5. Pingback: Valeant: Is giving away cheap drugs a good business model? | Glenn Chan's Random Notes on Investing

  6. Pingback: Saving time with Gurufocus and Google Sheets. Plus, the usefulness of Free Cash Flow. | Glenn Chan's Random Notes on Investing

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