Michael Kors (KORS) – Are these LEAPs cheap?

(This idea is not liquid as it involves LEAP options expiring Jan 2017.)

KORS is a luxury goods company with extremely high growth (44%+) and returns on capital (86%).

The trade I am interested in is going long KORS call options and long COH put options.  I think that both trades are compelling by themselves.  See my old and brief writeup on COH for my thesis on that company.  This post will focus on KORS.  The reason to go long KORS call options are:

  1. Implied volatility is reasonably low (around 34-35).
  2. Given the company’s ridiculously high growth, there is a good chance that the stock may see a lot of volatility on the upside.
  3. The P/E ratio is around 16.6 and the PEG ratio is 0.84.  Arguably, the company is reasonably cheap from a GARP perspective.

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Why I’m not shorting Canadian real estate

  • Comparing Canadian real estate to the US, Canadian underwriting is tighter.  Compared to the peak of the US subprime bubble, Canadian underwriting is far more conservative.
  • Comparing real estate to oil&gas and mining, there is far less fraud in real estate.
  • Based on price per square foot… the most overpriced market is China, then Australia, then Canada, and then the US.

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Companies with verbal agreements

The CalgaryLawyers.ca website states one reason why verbal agreements are a bad idea:

The biggest problem with verbal agreements (also know as oral agreements) is proving them. If one person says that an oral agreement was reached and the other party denies the agreement, it may be difficult to enforce the agreement.

From an auditor’s perspective, verbal agreements may be problematic because they do not generate a paper trail.  I do not see problems with verbal agreements if they are later followed up by written agreements.

When I analyze a stock, oral agreements are a minor red flag.  It may be a sign of sloppy work or stupidity.  It could be more.  One way to identify potential shorts is to look for these agreements (e.g. by using Edgar’s full text search).  However, that is not how I find shorts.

Here are some publicly-traded companies with oral/verbal agreements/arrangements.

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Ocwen/Altisource: What went wrong

Lessons learned:

  1. Regulators are difficult to predict.
  2. Don’t underestimate the amount of damage that a regulator can do.
  3. Use small position sizes for companies with potentially nasty regulatory risk.

While I was always aware of #1, #2 is what really got me into trouble.  Due to the actions of the NY DFS, I do not see the subprime mortgage servicing industry as an attractive one.  Lawsky may succeed in regulating away the industry’s profitability and crippling the growth of subprime servicers.

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Ocwen provides disappointing company update

Today, Ocwen provided a company update for its shareholders.  While the stock is up ~14% on the news, I am disappointed with how the current CEO is running the company.

  1. The update doesn’t seem to mention anything about buying back debt, which currently has fairly high yields (12-13%).  To me, this seems like an obvious move to make.  Where else might Ocwen get such high returns on capital with little risk?
  2. The company has halted its share repurchase program.
  3. The company intends “hire two financial advisors with significant experience in asset backed financing, capital markets, corporate and mortgage finance”.  I’m not a fan of companies that piss away money on overpriced labour.  Ocwen previously gave its CFO a raise in Dec 2014 but apparently he’s not good enough at his job that Ocwen now needs to hire outside talent.

So far, it seems that the new CEO is bad at capital allocation and bad at maintaining Ocwen’s status as a low-cost operator.

EDIT (2/6/2015): The update also indicated that the company may not be in full compliance with the CFPB metrics:

On the National Mortgage Settlement front, although we do not have the final results of the retesting of certain 2014 metrics by the National Monitor overseeing compliance, we do expect that, similar to many other Servicers in 2014, we will have metrics that will require remediation through corrective action plans as defined by the settlement.

Private placement pitfalls / Pinetree post-mortem

Some publicly-traded companies regularly participate in private placements.  One subtlety about private placements is that the buyer receives shares at a discount to the market price.  Participating in private placements can generate immediate mark-to-market gains.  This can make short-term performance appear better than it actually is.

In the long run, I think that private placements are a bad idea for investors for the same reason that secondary offerings are a bad idea.  It is difficult for the incoming shareholders to make money given the conflicts of interests (existing shareholders prefer to sell shares at inflated prices) and the extreme fees (typically several percent or higher).  An alternative to a private placement is a rights offering.  Rights offerings are considered to be fair to all shareholders and can potentially have very low fees.  However, very few Canadian juniors actually go that route.  Most companies choose to dilute shareholders and to generate massive fees for brokers, underwriters, lawyers, accountants, etc.

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