Data centers – Part 1 – Overview

In data centers, the most interesting areas currently are in:

1. Software.  In particular, Amazon has been a pioneer in creating value-added software that helps software companies quickly setup databases and servers and backup storage.  Google, Microsoft, and IBM/SoftLayer are doing somewhat similar things.  The problem is that the data center segments of these companies likely will not move the needle much.
2. IT services.  Rackspace in particular is doing very interesting things.

The least interesting areas are companies that are mainly involved in selling space in a building because that business is a commodity.  Those companies will not  make a lot of money and they will not lose a lot of money.  While I think a lot of the data center REITs are overvalued and are suckering institutional investors into overpaying for their stock, they are not compelling shorts because they aren’t losing money quickly.  As well, many (legitimate) data center companies have been taken over at large premiums by companies like Verizon and Cogeco Cable at valuations I would disagree with.

*Disclosure: No positions.

A quick comment about Chinese frauds and leaving racism at the door

The rampant fraud among Chinese reverse mergers and Chinese stocks listed on foreign exchanges has very little to do with ethnicity.  If you are a student of the game, you can figure out the ethnicities and nationalities of the people involved.  For example, many of the accomplices are American stock promoters with American citizenship.  There are also Canadians involved with the American-listed (and Canadian-listed) scams.  It’s silly to discriminate based on race or nationality.  What you really want to do is:

1. Discriminate based on integrity and track records.  People who have committed fraud in the past will likely commit fraud in the future.
2. Look at areas that would be magnets for fraud.  Legally, there is no extradition treaty between China and the US/Canada.  This means that Chinese citizens can commit egregious frauds in American stock markets with virtually no consequences.  The reverse is also true.  A quick Google search for “EB-5 scam” will reveal various ways in which Americans scam Chinese nationals through the Immigrant Investor Program.

Notes on cable – Part 6 – Piracy

Piracy is going to get a lot better in the future.

1. Internet speeds will get faster due to Moore’s Law.
2. Open source software will get better as contributors keep adding code.

My belief is that many of the dynamics that played out for the music industry will play out for piracy.  Piracy itself is a form of competition.  Content companies will be forced to compete with their own content.  The companies that will fare best against piracy are the ones who can put together an offering that is more compelling than piracy (e.g. Netflix).

In the long run, I think that most of the industry will be dominated by a small handful of Internet TV services with big content libraries and excellent software.  Content companies will increasingly need to become good at software.  Usually software markets are dominated by a small handful of companies.  If that’s the case for Internet TV, then many of the traditional players will be losers.

Unusual risks at Ocwen

Unfortunately for me, the drama never seems to end at the Erbey complex (OCN/ASPS/HLSS/RESI/AAMC).  Ocwen’s regulatory problems has been cascading into other problems.  I suppose the lesson here is that some companies sit on very unusual risks.  When it rains it pours.

I believe Ocwen’s financing deal with HLSS exposes it to a very unusual risk.  Ocwen had (more or less) sold excess servicing rights on its MSRs to HLSS.  If Ocwen loses its MSRs, then it has to compensate HLSS for HLSS’ loss.  The payment will be for the purchase price of the excess servicing rights adjusted for run-off at rates pre-determined in the contract between Ocwen and HLSS (8-K filing).

OCN, ASPS, NSM, and inflated fees

I made a mistake.  I did not figure out the game that Ocwen and Altisource are playing.  Ocwen seems to receive fees from Altisource that could be (mis)construed as kickbacks under its “Data Access and Services Agreement”.  These fees could be seen as a quid pro quo (“you scratch my back I’ll scratch yours”) for the big profits that Altisource formerly earned for lender placed insurance “brokerage”.

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.

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.

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.

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.

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.