Review of Current Losing Positions: NZT, ACAS, SKM, GE

A few weeks ago, a reader asked me about my current thoughts on Telecom New Zealand, which, as of 07/01/2008, was down 16.5% since I bought it last year. The blog’s hacking sidetracked me a bit and also, I’ve been “rolling” NZT and its future prospects in my head for a while. But judging from today’s visits, it looks like visitors are very worried about ACAS as well so a quick review of my current losing positions (NZT, ACAS, SKM, GE) may be of benefit to readers as well as myself:

Telecom New Zealand (NZT) — At this point, I’m willing to concede that my initial thesis was wrong on various counts:

• I did not accurately gauge the deterioration of their operating results. My initial projections were a 6-8% decline in EBITDA the first year and an overall negative 1% growth for 5 years after. Instead, they are announcing another 5% avg EBITDA decline for next FY in conjunction with an increased capex spend (as much as 10% higher YOY).
• Additionally, nothing in management’s discussion of the company gives me confidence that NZT has any solid plans to reverse their sliding market position. As of Q3 2008, pre & post-paid ARPUs have fallen 9% and 20% respectively and I can’t tell you any solid plans they have to change this.
• NZT has also failed to act as a hedge against the dollar as the NZ$ has fallen roughly 5% since we’ve opened our position. While this may change as the US$ reveals the extent of its structural flaws, the New Zealand economy is not the Australian or Brazilian or even a Southeast Asian economy. New Zealand has fallen into recession, which may weigh on any positive currency effects for some time.

With all that said, the time for me to sell was a few months ago. NZT has now fallen to levels where downside risk seems fairly limited to hold, especially considering the dividend. I have yet to average down on this stock, which is probably the best indicator of my opinion on NZT. I may (or may not) sell this stock later to harvest tax-loss but not until after the pay-up Q4 divvy.

American Capital Strategies (ACAS) — I got a lot of hits on my website today, apparently from concerned shareholders worried about the constantly-dropping share price.

• Obviously, I was a little early on ACAS but after searching for news on the company, I stand by my assessment on the stock. I see no substantive new information to change my stance.
• As Jim Cramer once stated, ACAS is a battleground stock. For me, it all boils down to this quote from the company’s 2006 annual report: “DIVIDENDS — THE MARKET CAN’T REVALUE IT AND WE CAN’T RE-STATE IT.” If the company can hold ground on the dividend through the credit crunch, shareholders are going to be amply rewarded.

Based on their track record and prudent outlook going forward, I believe CEO Malon Wilkus and company will continue proving the skeptics wrong. But investors should be prepared to collect the dividends and ride out further book value writedowns, increased non-accruing loans, aggressive shorting by hedge funds & wild volatility as ACAS gets lumped in with all the other financials. A careful perusal of my portfolio page will show that I have sold additional (as of now, in-the-money) put options for an effective price below $20 per share.

SK Telecom (SKM) — The South Korean won has not held up well this year against the US$, with the dollar up 12% this year against the won. This accounts for most of the 16.4% drop for SKM. On an operational basis, SK Telecom remains in an intense competitive battle with KT and LGT with a government that still appears meddlesome but results have held up reasonably well. Neverthless, SKM has also been a disappointment thus far for several reasons:

• I came to SKM via researching its competitor, KT Corp (KTC). KTC has outperformed SKM by over 9% since I opened the position. While it remains to be seen whether this trend will hold over the long-term, the market is saying I picked the wrong stock.
• SKM pays a semi-annual dividend with a pay-up dividend at the end of the year so I miss out on the comfort of a nice dividend to cushion the declines of a bear market.

[UPDATE: 07/08/2008: Reports have the S. Korean government intervening now in the currency markets to bolster the won and promising to do more. The possibility of the government failing to achieve its goal and the fallout from that failure is a disturbing prospect.]

At this juncture, I remain comfortable with the am holding SKM. South Korea has some political turmoil due to the new President’s unfortunate foray into beef imports and the economy is showing signs of slowing. But the company continues to hold market share, margins aren’t slipping precariously and cash flow is still decent.

General Electric (GE) — in short, I have added to my GE positions. After that last earnings miss and 7 years of a stagnant stock price, CEO Jeffrey Immelt is officially on the hot seat and will have to deliver not just improved results but an improved share price and soon. Personally, I would like to see the company sell NBCU as a start and perhaps trim down this conglomerate a bit to allow it room to grow. My sense is that Immelt’s credibility is now on the line and he will have to start taking more explicit measures to increase shareholder returns (beyond buybacks). While I’m a big fan of Immelt (even now), a change at the top may pop the share price. Patience may be required but at these levels and with a quarterly dividend approaching 5%, it should be worth it. For more on my views on GE, please see these previous posts.

Disclosure: Long all stocks.

Comments

[CharlesGoldblum]

I, and my clients, own SKM. You'll be fine here, if not excited. Double-digit free cash flow yield is safe, risk is only what company will do with this $. Sell-off of Helio is a plus.
Sell ACAS. Bad accounting. Bad valuations of its investments. Will continue to fall. For the script on this one, read David Einhorn's book, "Fooling Some of the People All of the Time"

[CharlesGoldblum]

Sorry about republishing this, but here's my info - so I'm not anonymous.

I, and my clients, own SKM. You'll be fine here, if not excited. Double-digit free cash flow yield is safe, risk is only what company will do with this $. Sell-off of Helio is a plus.
Sell ACAS. Bad accounting. Bad valuations of its investments. Will continue to fall. For the script on this one, read David Einhorn's book, "Fooling Some of the People All of the Time"

[helplessobserver]

In a bear market quality counts for everything. GE is quality thru and thru and the dividend helps with the wait.

[TKTK53]

Charles I hate to tell you as you seem to be a stockbroker, but ACAS is caught in the middle of this big turn down and it's price has dropped like all the rest. I think in the future you will be writing another comment saying you were wrong and it in part was your fault that 1000's of people took your advice and lost a lot of money
Remember once before when we had a turn down like this and it turned around and what happened ACAS went to about $40.00

[CharlesGoldblum]

TKTK -
For good order's sake, I do not own, nor am I short, ACAS. None of my clients have a position in ACAS.

I merely am pointing out aggressive accounting tactics used by ACAS and others. Will the stock go up or down, I don't know. I advise steering clear of operators such as these. I'm not an expert in ACAS, but paraphrasing Warren Buffett, in investing one need not swing at every pitch. For the reasons stated here and above, I'd advise passing.

Regarding your inflammatory remarks about losing people money, you can find my firm's name through my blog. On my company website I have quarterly newsletters showing verified performance of a composite of client accounts. I submit that my client recommendations have not lost "1000's of people...lots of money".

You're entitled to your opinion. In investing, it's important to do your homework first.

[southshoreinvestor]

The above assesment of ACAS is off the mark. I would challenge the Einhorn book and refer anyone to the following link: www.deepcapturethemovi.../ for an alternate view.

ACAS is no different than any other company holding private businesses and loans in their portfolios. With the implimentation of fas157 level 3 assets (those not readily traded) are valued based on recent sales. Thus, of course if no one is buying, then the values of these investments must be marked down to ridiculously low levels.

However, the majority of these private businesses and loans will be held long term and provide stable interest or dividends to ACAS. When liquidation by over-leveraged hedge funds ends and the market fear subsides, then there will be a reversal of the valuations. That is when those short will become longs.


What you believe is up to you........... do your own DD.

---------------

* The actual issue, IMO, is the rising cost of capital.

REITs, BDCs, MLPs, etc., that pay out most of their income rely on secondary offerings, preferreds and convertibles, and sell-downs of mature assets to pension funds for new capital to fund their business's growth. However, they all have variable ratios of fixed and/or variable rate debt.

1. New fixed rate debt will be harder to obtain and more costly.
2. Secondaries will be less accretive to NAV, OR even dilutive if required to capitalize unfunded commitments.
3. Convertible or preferred share offerings will likely be less attractive.

On the down side, these businesses may face slower growth prospects combined with decreased demand for their underlying assets (REITs = mortgages, leases, etc.; BDCs = private businesses and loan market; MLPs = pipeline volumes) resulting in decreasing earnings growth, decreasing NAVs, and falling dividend/distribution coverage. Dividends for some securities and CEF's, even while "banked" from prior years may reduce NAV in the short term.

On the positive side, those BDCs and REITs with capital can take advantage of the more favorable lending environment and distressed securities/loans. Those MLPs with a greater fixed rate debt ratio, longer terms on debt, lower unfunded commitments, and higher regulated percentage of business will benefit. Buying into the best companies at attractive yields will position one for multiple years of attractive gains. Look for a reversal in NAV when the hedge funds have finally de-leveraged / liquidated.

[jjason]

Charles, ACAS has some advantages over other companies like:

1. No intangible assets.

2. A very good Yield.

3. ACAS is selling below book value.

4. Recently (because of FAS 157 ) assets were written down. These assets will be held to maturity so, at maturity, these assets will be written up.

5. The total debt to equity ratio is, by law, always less than 1 to 1.
This means that ACAS is not overleveraged.


6. ACAS is well managed.

I have no idea what David Einhorn said in his book. If I could write laws, I would make hedge funds and short selling illegal.

Finally, Charles, you make statements about ACAS without any data. I find this unacceptable.

If you actually know something about ACAS that is detrimental then please share it with us.

Long ACAS

[Joe E]

Re ACAS. I own some, and some of ALD, another similar company. It is simply true that the secondary market for their equity ownership in the smaller companies they help develop has gone down. Same reason GE is down -- soft economy, tough to borrow money, capital preservation more important than risktaking right now. It is also true that some of the loans they made in the past at what were then good interest rates they would not make now. This makes those loans worth less if they were to sell them. We can expect the dividends to come down over time, in spite of their good record in the past.
Is all this doscounted in the price? Who knows? We do know that Wall Street hates to own companies that will report declining earnings next quarter no matter what the long term might hold.
Over time they should be OK. They are in a good business, their competition is weakened and they are not overleveraged. The biggest risk is that they become fixated on maintenance of the dividend and weaken their companies. Same problem REIT's have. The market clearly expects dividend cuts in the future and so should we.

[najdorf]

jjason: I think you're missing several of the points.

Your #3 is nice, but when the book value of a company is largely determined by a number that they make up for loans that may or may not be repaid and business interests that may or may not be profitable, it's concievable that the book value might drop in the future. The fact that the company can be bought for less than said book value is one indication that maybe their internal valuations aren't quite accurate.

Your #4 is also very nice, but companies love to make this claim when they write assets down and it's not always the case. If it's Warren Buffett noting a share-price decline in Coke, maybe you should believe him. If it's some guys telling me that their junk bonds and mortgage-backed securities totally won't default because those underwater homeowners and small companies paying 15% interest are risk-free money, I'm a little skeptical.

#5 really depends on your definition of "over-leveraged&q... What kind of rate are they paying on that debt? How well is it covered by income? If income craps out, how long before the debt eats up the equity and company has to raise capital at unfavorable terms?

#6 would be sweet if any evidence were attached.

I don't know why people can't just accept that risk and reward go hand-in-hand. You're not getting a risk free 15-20% yield when you buy shares today in companies like ACAS and ALD. You could make a lot of money or you could lose all your money. If you want risk-free you have to put up with Treasury yields.