LMCA/LMCK share class arbitrage

LMCK shares have no voting power while LMCA shares do.  In theory, LMCA shares are worth more than LMCK shares and should therefore trade at a premium.  Right now, the opposite is true.

Class A:  Ticker symbol LMCA.
Class B: Ticker symbol LMCB.  These shares have the most voting power.  These shares are highly illiquid.
Class C: Ticker symbol LMCK.  Non-voting.

In theory, you can arbitrage these shares by shorting LMCK and going long LMCA.  I would not recommend that particular trade because I’m not a fan of share class arbitrage in general.  But if you enjoy risky arbitrage trades that may take years to work out, there are better share class arbitrage opportunities out there.  For example, the spread is dramatically higher with LEN and LEN.B (18.7% versus 0.6%).

Altisource recap

This is just my opinion, but I think that Altisource is pretty cheap despite being one of the fastest growing stocks around.  Here are the company’s historical earnings per share (diluted):

2008: $0.38
2009: $1.07
2010: $1.88
2011: $2.77
2012: $4.43
2013: $5.19
Trailing twelve months: $6.69

Despite this incredible growth, the current TTM P/E is 12.8.

(Ocwen/Altisource) Force-placed insurance

Altisource’s share price fell dramatically today following a letter by Benjamin Lawsky to Ocwen (PDF link) that finds problems with a practice called force-placed insurance.  Normally, lenders will require the homeowner to pay for hazard/property insurance.  Part of each mortgage payment goes into an escrow account that pays for insurance and property taxes.  However, there are some rare cases where the borrower pays hazard/property insurance separately.  Perhaps they already had insurance before getting a HELOC.  Or, they wish to exercise their right to choose their own insurance provider.  In those situations, a borrower who has run into financial difficulties may stop paying their hazard/property insurance because they have more important expenses to pay.  This exposes both the lender and the borrower to the risk of catastrophic damage to the home.  Mortgage contracts generally allow the mortgage servicer to obtain hazard/property insurance elsewhere on behalf of the borrower.

There are two issues with force-placed insurance:

1. It’s almost always significantly more expensive than the original hazard/property insurance policy.
2. The mortgage servicer can take kickbacks/commissions from the insurance company.

(Ocwen) RMBS arbitrage

(This post is about a new venture at Ocwen that will likely be immaterial.)

On the latest conference call, Bill Erbey commented that Ocwen will be pursuing a new RMBS arbitrage strategy:

I believe that Ocwen has substantial opportunities to leverage our strong servicing capabilities by exercising cleanup calls, call rights or investing in existing private label RMBS tranches that we service. Most of RMBS securities we service have cleanup call provisions that allows the servicer to call the deal at par, typically when it has been paid down to 10% of the original unpaid principal balance. Notwithstanding slower prepayments, we see a steady stream of deals maturing in the next several years.

The opportunity results from the arbitrage of the underlying loans in REO being worth more than the securities. In other words, the whole is worth less than the sum of the parts. A condition precedent to our investment is our belief that Ocwen’s servicing creates strong cash flows for the securities overall. We’re building out this program and expect to be in the market purchasing securities in the next few months.

Perhaps some enterprising hedge funds will try to front run Ocwen.

Ruger Q2 2014 update – Part 2

I don’t think that investors should panic over Ruger’s drop in EBITDA and distributor orders.  Going forward, I see the company gaining market share as its continues to release new products (which it has done so in the past).  Volumes and profitability should recover and grow.

That being said, a huge contraction in the gun market or intense competition can hurt Ruger shareholders.  I have no special insight into what will happen to the overall gun market.

Ruger Q2 2014 update

Ruger is seeing weak demand for its products and is slowing down production in response.

The press release and quarterly financial statements can be found on the company’s website (PDF).  The 10-Q is on EDGAR.

Notes on Demand Media and Rightside

These companies do not seem compelling to me as investments (long or short).  However, I feel like these companies are somewhat misunderstood because some analysts don’t understand the industry.

(LMCA) Liberty Broadband spin-off

Liberty recently completed the distribution of 2 class C non-voting shares (ticker symbol LMCK) for each LMCA or LMCB share.  Now Liberty intends on completing its spinoff of Liberty Broadband (LBRDA/B/K).  Each shareholder of LBRDA/B/K will be slated to receive rights (LBRKR) to purchase shares of LBRDK.  Liberty Broadband’s S-1 was filed on July 25.

To summarize:  I think that both the parent and the spinoff will be attractive stocks.  I plan on owning both.  It could make sense to be overweight Liberty Broadband.

Both parts will essentially consist of high quality businesses with high growth (Sirius XM and Charter).  I don’t believe that this spinoff will result in a special situation where one piece will contain significantly better assets than the other piece.  I think that it is a better idea to own both rather than just Liberty Broadband.  Because there will be a lot of leverage underlying the companies, it is probably a good idea to diversify.

Short selling update July 2014

So far I have shorted the common shares of more than 80 stocks this year.  On common shares, I have been profitable overall despite a rising market.  Unfortunately, losses on put options (mainly YONG) have more than wiped out the gains on my common stock shorts.

I think that I’ve gotten fairly good at spotting bad stocks.  My CAPS account is a reflection of that.  (*CAPS does not consider the mechanics of borrowing shares.  It’s unrealistic.)  Unfortunately, I’ve been losing money on put options this year.  Part of this may be because I mainly short small cap stocks which are too illiquid to buy put options on.  As well, many of my shorts are volatile so the put options would be neither cheap or attractive.

See below for commentary on certain positions.  Keep in mind that due to the sheer number of positions, my research on short positions is typically very shallow.

Most of the time nobody will explain the game to you

In many areas of life, the sharpest people in a given field often won’t explain the tricks of the trade to the general public.  Sometimes it’s the case that the publicly-available information on a subject is second-rate.  Take Warren Buffett for example.  His derivatives deals are brilliant because he is getting paid to borrow money.  Of course, he does not fully explain his deals because he doesn’t want others copying his trades. In shareholder letters, he does not explain how his counterparties were inappropriately modeling equity-equity correlations.  He only discussed the trades on a superficial level because GAAP accounting of the derivatives were causing people to misunderstand Berkshire’s intrinsic value.  Buffett likely avoids explaining Berkshire’s credit default contracts for similar reasons.