Wednesday, August 18, 2010

Lesson on 13F's From Whitney Tilson & an Update on Their InterOil Short Position

Whitney Tilson, hedge fund manager of T2 Partners recently commented on the latest round of SEC 13F filings and how people tend to misread them. We thought this was an excellent time to continue our impromptu lessons on 13F filings that we started yesterday. Today's topics? Discerning net exposures in positions and distinguishing when ownership of common stock is not necessarily a long position. The following is printed with permission from Mr. Tilson regarding message board participants improperly reading his firm's 13F:

"It says a lot about who owns InterOil when folks on the company’s message boards are saying we’ve gone long the stock based on our 13-F. HA! This is a very large bearish bet for us. A lot of people make this mistake when reading 13-Fs: managers often own puts (which are also disclosed in the 13-F) or are short a stock (which isn’t disclosed) and then own a small offsetting long position to make it easy to trade around it.

In our case, our 13F shows that as of 6/30, we owned 1,623 put contracts (representing 162,300 shares of stock) on IOC and, in addition, were long a mere 10,400 shares. Puts can be very hard to trade, so we just bought more puts than we wanted and offset the extra amount by buying some stock, resulting in the desired net exposure. Then, if we want to increase or decrease our bearish bet, we can simply buy or sell the stock."

This just reinforces the need for investors to *read* 13F filings carefully. In particular, make sure to glance at the right-hand columns on the filing to distinguish whether a position is a stock option (put or call) rather than just common stock. Just yesterday, Bloomberg omitted options positions from an article on 13F analysis. And today, we see that message board readers have either overlooked the options portion of T2's filing or misinterpreted their common stock position.

T2's actions of buying puts and then buying a small slice of common stock illustrate an important example of liquidity and having the ability to trade around a position. This becomes even more important in stocks that are heavily shorted and can swing wildly with volatility. So if a hedge fund owns multiple securities of the same company, you have to assess the values of each individual security to ultimately determine if it is a bullish or bearish wager. And in T2 Partners' case, they own way more puts than common stock, resulting in an obvious bearish bet.

Tilson also updated us on T2 Partners' short position in IOC. We've detailed this stake numerous times in the past as it's rare you see fund managers talk openly about their short positions. As such, we've taken the opportunity below to highlight Tilson's recent thoughts on InterOil:

"We added to our bearish bet (yesterday), as InterOil reported Q2 earnings yesterday that reinforced our investment thesis. The earnings and EBITDA (driven by the refinery operation) are irrelevant for a company that has a $2.9 BILLION (not a typo) market cap; what really matters if whether there is, in fact, the Sierra Madre of oil and gas in the areas being explored by InterOil and, if so, whether they have the cash to find it, develop it commercially, etc.

Re: the former, there continues to be no proven or even probable reserves – just more hype and gibberish like this from the earnings release:

The Antelope 2 horizontal well confirmed a higher condensate-to-natural gas ratio of 20.4 barrels per million cubic feet of natural gas, 27% higher than observed at the top of the reservoir. The horizontal well also demonstrated dolomitization and higher porosity deeper in the reservoir than previously modeled.

And re. the cash, this company is going to hit the wall soon. Over the past four quarters, net income is -$1.3 million and free cash flow is -$181.9 million (cash from operating activities minus “expenditure on oil and gas properties” and “expenditure on plant and equipment, net of disposals”, broken down as follows:

Q3 09: -$48.6 million
Q4 09: -$40.7 million
Q1 10: -$28.5 million
Q2 10: -$64.1 million
TOTAL: $181.9 million)

So with no profits to fund such massively negative cash flows, how is InterOil doing it? Answer #1: Burning through cash (unrestricted cash has declined from $96.4 million a year ago to $31.7 million today). Answer #2: Taking on debt (the working capital facility – short-term debt – is up from $4.0 million a year ago to $57.7 million today, partly offset by a $9 million decline in a secured loan). Answer #3: Issuing stock and conversion of debt ($12.8 million over the past 12 months), resulting in the diluted share count rising 16.1%. Answer #4: Misc. other stuff (“Proceeds from IPI cash calls” ($15.2M in the first two quarters of 2010), “Proceeds received on sale of exploration assets” ($13.9M in Q1), and “Proceeds from Petromin for Elk and Antelope field development” ($5M over the past 12 months).

To summarize, InterOil has only $31.7 million in unrestricted cash as of June 30th and they’re burning an average of $45.5 million of cash each quarter. No wonder the company entered a short-term $25 million credit facility last week on distressed terms: 10% interest (in this environment!), secured by a 2.5% stake in InterOil’s Elk and Antelope fields. Note that the provider of financing was a very dicey outfit, Clarion Finanz and known stock promoter Carlo Civelli – see this post."

In the past, we've also highlighted some of T2's other short positions for those interested. And for more on interpreting SEC filings correctly, head to our post from yesterday regarding Eric Mindich's hedge fund Eton Park and lessons regarding 13F filings.

Kyle Bass Betting Against Japanese Government Bonds (JGBs)

Kyle Bass of hedge fund Hayman Advisors has a very dim outlook on parts of the world. In a recent interview with CNBC, Bass laid out his themes his hedge fund is playing and positions they've taken as a result. Remember that Kyle Bass will be presenting ideas at the Value Investing Congress in October as well. Market Folly readers can receive a discount here.

Hayman is positioned to benefit from a Japanese restructuring that will likely take place over the next few years. Bass defines the Keynesian end-point as, "when your debt service excedes your revenue". And, he thinks Japan is there. Japan's tax receipts in nominal terms are the same as they were back in 1985, whereas their expenses are 200% higher. He argues that Japan is in secular decline and they're spending roughly twice what they make. Japan has funded themselves by selling bonds to their citizens at low rates and he doesn't feel they'll be able to do this anymore.

As you can see, he has outlined tail risk plays. At the same time, he is trying to earn nominal returns while he waits for these tail events to pay off. As such, 35% of Hayman's investments are in US Mortgages, 25% are in bank debt, 17% are in U.S. distressed positions, and 23% are in high yield. Now these are some of Hayman's 'core' positions but it sounds as though Bass thinks his tail positions could possibly generate quite a return.

In particular, he's focused on Japanese Government Bonds (JGBs). Of them, Bass notes, "At a time at which the bond I think is the most risky asset (or one of them) in the world, the pricing of that asset using the Black-Scholes model is the best it's ever been. So you have this huge convex moment that you can put enormous positions on in Japanese interest rates very cheaply."

Overall, in terms of tail risk plays, he's positioned 10-15% of his portfolio betting against European sovereigns and Japan. Given his view of the world, Bass doesn't know how you can be long stocks. If you want to become instantly depressed, he's the guy to talk to. And Bass isn't the only well known investor betting against Japanese JGBs. In a recent interview, Passport Capital's John Burbank has been short Japanese Government Bonds as well.

Embedded below is a video of Kyle Bass' recent television appearance (email readers will have to come to the site to watch it):

To hear both John Burbank (Passport Capital) and Kyle Bass (Hayman Advisors) present investment ideas, register for the upcoming Value Investing Congress (special discount here).

Tuesday, August 17, 2010

Gold is NOT Eric Mindich's Biggest Holding: A Memo to Bloomberg Regarding 13F Filings

Yesterday afternoon, Bloomberg ran a piece entitled, "Eric Mindich, Like John Paulson, Makes Gold ETF His Fund's Biggest Holding." There's just one problem with that headline: it's not really correct. Here at Market Folly, we pride ourselves on in-depth analysis of SEC Filings, and in particular, the 13F's that disclose the latest hedge fund investments. And today, we get the perfect chance to prove it.

The SPDR Gold Trust (GLD) is not the largest holding at Eric Mindich's hedge fund Eton Park Capital Management. As per the most recent 13F detailing positions as of June 30th, 2010, Eton Park's largest position is puts on the iShares MSCI Emerging Market Index (EEM). At quarter close, Mindich's position in GLD was valued at $800,289,000. His put position on EEM was valued at $895,680,000. In the second quarter, Eton Park actually increased their bet against EEM by 61%, buying puts representing 9,100,000 additional shares. Their put exposure on this name now represents 24,000,000 shares of EEM.

Maybe Bloomberg's data-set didn't take into consideration the put/call column on the actual filing. (Numerous automated data sorting programs skip over this and omit options positions entirely). Maybe it was an honest mistake. Maybe Bloomberg doesn't classify puts as an 'investment' and so it merely comes down to technicalities of the language used in their article. But even if that was the case, you still can't really call the SPDR Gold Trust their single 'biggest reported investment'.

Why? Well, because Eton Park also owns both puts and calls on GLD as well. In the second quarter, Mindich's hedge fund bought the following:

$800,289,000 worth of SPDR Gold Trust (GLD) shares
$608,400,000 worth of GLD calls
$486,720,000 worth of GLD puts

We don't know their true exposure to gold because a 13F filing does not disclose the strike price or expiration date of underlying options positions. However, you could net out their ownership of common shares, calls and puts to find that they have around $921,969,000 worth of long exposure to GLD. But you also have to keep in mind that Eton Park is an arbitrage focused fund. As such, all of these discrepancies are relevant to determine the type of wager they are making with various positions.

The only way that GLD is Eton Park's top holding is if Bloomberg is treating all of the above as gross exposure to GLD or if they are netting out the exposure as we have above. But even then, there was no mention of this in their article at all. They merely cited the $800 million position in the underlying shares. The fact that Bloomberg completely omitted the information that Eton Park owns both calls and puts on the same exchange traded fund is somewhat appalling. It's one thing to own just the shares of GLD as a directional bet (as they've mistakenly construed). It's entirely different when you add in ownership of both puts and calls on the underlying shares as those affect the net position and exposure. Nevermind that Bloomberg missed the fact that their standalone position of GLD shares are not Eton Park's 'biggest reported investment' in the first place.

The comical part of all of this is that Bloomberg completely skipped over Eton Park's options positions in both EEM and GLD, and yet they end their article with this note (emphasis added by MarketFolly):

"The SEC requires money managers who oversee more than $100 million in U.S. equities to report their holdings on a Form 13F within 45 days of the end of each quarter. The filing must include all holdings in stocks that trade on U.S. exchanges, as well as options and convertible debt."

Factually, Eton Park's largest single reported holding is in puts of the iShares MSCI Emerging Market Index (EEM). Their position in shares of the SPDR Gold Trust (GLD) is the second largest reported holding. But even then, there's some ambiguity surrounding their entire GLD exposure and the type of wager they're making when you consider the puts and calls they also own. This just goes to show that attention to detail is a must when examining SEC 13F filings.

Apologies for this little diatribe, but it's irritating when potential misinformation is floated around, especially by a mainstream media source. In the end, Bloomberg will probably update the article from 'biggest' holding to 'big' holding or something of the sort (with zero mention of Market Folly of course). That's perfectly fine, as long as they remedy the misinformation that's currently out there. Our readers know where to come for hedge fund portfolio updates.

Stay tuned this week as we are set to release an in-depth summary of the new batch of 13F filings and latest positions of the top hedge funds in the game. For more on Eric Mindich's hedge fund, we also detailed Eton Park's new Doral Financial (DRL) position.

Monday, August 16, 2010

Eric Mindich's Eton Park Discloses New Doral Financial Position (DRL)

Per a 13G filed with the SEC due to portfolio activity on August 6th, 2010, Eric Mindich's hedge fund Eton Park Capital has disclosed a new position. Eton Park has revealed a 7.52% ownership stake in Doral Financial Corporation (DRL) with 8,444,354 shares. However, this percentage is based on the current amount of shares outstanding. Realistically, Doral will have more shares outstanding due to conversion of "mandatorily convertible non-cumulative non-voting preferred stock". So if you were to base the figure on the anticipated number of shares outstanding, Eton Park would own a 6.63% stake.

Breaking down the position at Mindich's hedge fund, we see that they own 3,827,091 shares of common stock and then 21,932 shares of preferred stock which will convert into 4,617,263 additional common shares. All in all, this is a newly disclosed position as it did not appear in our past coverage of Eton Park's portfolio. Mindich founded Eton Park after being named the youngest partner in Goldman Sachs history at age 27. He launched with $3 billion in 2004, one of the largest hedge fund launches ever. Mindich's hedge fund is primarily arbitrage focused and we've detailed some of their previous new positions as well.

Doral Financial Corporation is "a bank holding company. Doral Financial’s operations are principally conducted in Puerto Rico. The Company also operates in the New York City metropolitan area. Doral Financial manages its business through three operating segments: banking (including thrift operations), mortgage banking and insurance agency."

Stay up to date with the latest hedge fund portfolio movements on our site daily.

Eliav Assouline & Marc Andersen's Axial Capital Adds QLTI Again

Eliav Assouline and Marc Andersen's hedge fund Axial Capital Management are at it again. They've purchased an additional 100,000 shares of QLT Inc (QLTI) at a price of $5.70. The purchase, which took place on August 11th, 2010, means that Assouline & Andersen's hedge fund now owns 6,441,812 QLTI shares. As we've extensively detailed, Axial has been buying QLTI over the course of a few months.

Some investors have categorized QLT Inc as a value trap while others think of it as a 'cigarette-butt' value play. Essentially, many investors are betting on the biotech company's royalty stream. Those categorizing it as a value trap think that this royalty stream, while healthy now, is likely to decline. Andersen and Assouline obviously disagree with that take since they have been accumulating shares.

Axial Capital was listed as one of Institutional Investor's 'Hedge Fund Rising Stars.' The hedge fund was seeded back in 2005 by Julian Robertson and offices at the same 101 Park Avenue address as legendary hedge fund Tiger Management. You can view the proverbial Tiger Family Tree of managers that Robertson has spawned or seeded.

Taken from Google Finance, "biotechnology company. The Company is engaged in the development and commercialization of therapies for the eye. The Company focuses on its commercial product, Visudyne, for the treatment of wet age-related macular degeneration (wet AMD), and developing its ophthalmic product candidates."

To see what other top managers are up to, head to our collection of recent hedge fund investor letters.

Jack Schwager ~ Quote of the Week

Today's Market Folly quote of the week comes from Jack Schwager, author of many renowned books on financial markets, the aptly named Market Wizards series. Mr. Schwager has had the privilege of interviewing and interacting with many of the top hedge fund managers in the game. As such, he's built up quite a collection of wisdom. Here's our quote of the week focused on human behavior/psychology when it comes to risk & reward:

"In one experiment, subjects were given a hypothetical choice between a sure $3,000 gain versus an 80 percent chance of a $4,000 gain and a 20 percent chance of not getting anything. The vast majority of people preferred the sure $3000 gain, even though the other alternative had a higher expected gain (0.80 X $4,000 = $3,200). Then they flipped the question around and gave people a choice between a certain loss of $3,000 versus an 80 percent chance of losing $4,000 and a 20 percent chance of not losing anything. In this case, the vast majority chose to gamble and take the 80 percent chance of a $4,000 loss, even though the expected loss would be $3,200.

In both cases, people made irrational choices because they selected the alternative with the worse expected gain or greater expected loss. Why? Because the experiment reflects a quirk in human behavior in regards to risk and gain: people are risk averse when it comes to gains, but risk takers when it comes to avoiding a loss. And this relates very much to trading. It is exactly the quirk in human psychology that causes people to let their losses run and cut their profits short. So the old cliché of let your profits run and cut your losses short is actually the exact opposite of what human nature tends to do."

~ Jack Schwager

We highly recommend checking out Jack Schwager's books:

- Market Wizards
- Technical Analysis Study Guide
- Complete Guide to the Futures Markets

They are full of a ton of interviews and insight from top hedge fund managers, traders, and the like.