Have you ever wondered how WHX can remain above its fair value for so long? If so, you may be an unwitting gambler in a casino that has a huge house advantage, or one of many peasants among a few rich kings.
Whiting USA Trust 1 (WHX) is more involved than it appears to many retail investors, which is causing them to take on more risk than appropriate for the return, lose money when they think they have profited, and, even when they make money, to give up significant profit to their brokers and to more sophisticated large investors. Three of the reasons should be obvious to all serious investors. Three of them may not be obvious to all but the more sophisticated investors.
- Long-term dividend investors lose: WHX is a trust that, at current production rates, will end at $0 after 5 more distributions in early 2015. Every distribution removes value that will never come back to the trust. Long-term holding is, literally, a zero sum game.
- Long-term value seekers lose: The underlying value of WHX is more than a 50% discount to recent prices (week of 11/11). Value destruction is guaranteed.
- Short-term dividend seekers lose: WHX has fallen by more than its distribution on 90% of past ex-dividend dates since inception, often by double or more of the actual distribution. Short-term dividend seeking loses money.
- Shorts lose: Those who know the above and try to short WHX (if they can short it at all) incur extreme borrow costs, plus the risk of forced buy-ins when borrowed shares are recalled. Shorts can profit, but they have to time it just right or they lose too.
- Option buyers lose: Those who buy puts pay a huge premium for those puts with many expiring worthless. The value of the puts falls rapidly as WHX is driven up by investors 1-3 above, and time premium losses mount as they wait for WHX to come back down. If they are able to exercise their puts then they go short WHX per 4 above and suffer those added short costs and risks.
- Speculative buyers playing the distribution gap lose: This may be a surprise to those who know all of the above and try to time a long position. Those who buy after the post-distribution drop and hold until the peak just before the next distribution may appear to be doing well, but they are missing more than 50% in annual profits; those with margin accounts are giving those 50% in annual profits to their broker, for free. They must love their broker!
So, who wins with WHX? Your broker wins, in a big way, with no risk. The largest, most sophisticated investors win also. All at the expense of groups 1-6 above. Read on for an explanation of each point above.
1. Long-Term Holders Lose
Any investor who can read and has taken the time to do so knows that WHX will end at $0 in early 2015. Rather than beat a dead horse, I'll direct those who haven't read it to Whiting's own FAQ. Every distribution reduces the underlying value by the exact amount of the distribution until it is $0, with no opportunity to add back any more value. Higher distributions now only result in fewer and/or smaller distributions in the future. Zero Sum.
2. Value Seekers Lose
Calculating the value of WHX is very simple. While the above Whiting FAQ states June 2015 is the forecasted end date, keep in mind that was based on a December 2012 study. I predict that the December 2013 study will move that date up to as early as February 2015 (we'll find out at the February 2014 distribution announcement). Production rates have been higher than predicted since December 2012, hence the last two increased distributions. At current production rates, production attributable to WHX will be complete in January or February 2015, with the last full distribution in February 2015, and a very small (10% of normal) distribution after that. If production slows and distributions go out further, they also get reduced by a corresponding amount.
A simple, reasonable value calculation based on the latest distribution report is:
1,340,000 BOE remaining to distribute (8.2 MMBOE total - 6.86 MMBOE distributed = 1.34 MMBOE).
259,507 BOE current distribution to WHX (288,341 BOE X 90% attributed to WHX = 259,507 BOE).
5.16 distributions remain at current production levels (1,340,000 BOE remaining / 259,507 BOE last period = 5.16, this is where I get the February/March 2015 completion above).
$3.05 future value based on recent period (5.16 distributions X $0.592 last period = $3.05).
$2.75 future value based on lower energy prices (oil was abnormally high last quarter and has since dropped to normal historic levels as can be clearly seen in the below NASDAQ West Texas crude oil chart, down about 10% from the last period, $3.05 X 90% = $2.75).
$2.42 current value to get a 10% annual return, or 12% now until March 2015 ($2.75 X 88% = $2.42).
$2.42 is the most I would pay to buy WHX, more than a 50% discount from recent prices ($4.50 - $5.50). Half of the value at current prices will be lost!
Even with the recent drop this week from $5.50 to $4.40, WHX is overvalued by $2.00, or 45% yet to go down!
3. Short-Term Dividend Seekers Lose
This chart says it all. In all but 2 cases since 2008, or 90% of the time, WHX fell more on its ex-dividend date than the distribution itself. In many cases the difference is stark, up to double or more. You might get cash from the distribution, but you will lose on the trust unit price.
Last Friday's price held up more than the distribution, but since then it has plummeted. I hope dividend seekers got out Friday!
Read on to see the probable reason that it held up more than the distribution last Friday...
4. Shorts Lose
Those who know 1-3 above may try to short WHX. Anyone who has shorted WHX this year knows that the cost to borrow shares so that you can be short has averaged 50% or more, sometimes reaching into the 90%'s and even over 300% (i.e., NOW!). Waiting for WHX to fall is an expensive game.
Shorts also run the risk of having borrowed shares recalled at just the wrong time, forcing a buy-in. This often happens the week of distribution when lots of units change hands and WHX's price is going up. Short forced buy-ins may have supported some of last week's buying and ridiculous increase in price to $6.30, as well as Friday's hold above $5.40.
Shorts are doing what they can to take WHX to fair value. But they are up against limitations that they cannot control, which often makes them lose.
5. Option Buyers Lose
Those who know 1-4 above and still want to take advantage of this situation may turn to options, only to be disappointed. WHX puts have been extremely expensive, reflecting the above downside risks and implied volatility of WHX. There is a correlation between the cost to borrow units and option prices (both are very high).
November 1, two weeks prior to the latest distribution, the November 15, $5 Puts were trading at about $0.50 even when they were out of the money. The open interest in those puts was 4,500 (controlling 450,000 trust units) on last Friday's expiration (11/15). With WHX closing above $5, all of those previously expensive puts expired worthless. Ouch!
Granted, those who sold the puts made out nicely. But my educated guess is that most investors were buying the puts and it was market makers who were writing them and hedging those positions, given the very high put premiums recently. Market makers don't typically drive up option prices. Investors do that.
6. Speculative Buyers Lose
Some speculative buyers who buy after the post distribution drop and sell at the peak just before the next distribution may have done well this year. But do they realize they have given up 50% or more in annual profits to their broker for the past year? Right now that is closer to 300%!
Missing 50% In Loan Value
The 'borrow rate' for WHX, which short sellers pay to those who loan out the units, has hovered 30-70% since at least the beginning of the year. (It's a bit more complicated in that the high interest is based on the collateral provided to the party loaning out the shares to ensure they are returned, but you can look at it as a simple cost to borrow units). If you are able to short WHX, you will see the borrow rate first-hand, because you will pay it. Those who own WHX, if they could loan the units out themselves, would have made 50% annually on those loans for most of this year, regardless of the stock market return on the trust units themselves. Again, right now that rate is over 300%!
Retail Non-Margin Account Investors Cannot Loan Their Shares
But most retail investors are not able to loan their shares out themselves. If they have a non-margin account, the shares are probably not able to be loaned out at all. These WHX owners are supporting those who do loan out the units by limiting the loan supply and helping increase the loan rate. They are also supporting the unit price by not allowing others to short it. They may think that's in their interest, being long WHX. But considering the 50% annual loan interest they are missing and being in a simple non-margin account, they likely fall into groups 1-3 above, and they lose out overall.
Margin Account Holders Give Their Broker Free Money
If WHX unit owners have a margin account (individual investors), their broker probably loans out the units and keeps the loan interest for itself. At $5 over the last 6 months, $1.25 of WHX value has been taken by brokers loaning out the shares, or 25% (50% annually), with little to no market risk on the broker's part!
Right now (11/18) the daily loan value is $0.05 per trust unit (300% annual interest)! If you are long WHX in a margin account and not loaning out your units, but your broker is loaning them out, you are giving $0.05 per unit to your broker every day you hold. Those low commissions don't look so great anymore!
$3,750,000 Given To Brokers and Large Investors
Some might think this is a small amount. At an average short interest of 1,200,000 units this year, assuming a 50% annual borrow cost and a $6.25 average price (rounded up to the next dollar for borrow cost, or $7), that is $3,750,000 given up by individual investors! A total of about $22 million has been paid out in distributions by WHX this year. An additional (estimated) $3.75 million has been made in loan interest! At the current rate (300%), lots more will be made off investors in a short time.
Sophisticated large investors and institutional investors with access are able to capture some or all of this $3,750,000 loan interest profit by loaning out their shares in the opaque stock loan market.
The Deck is Stacked Against You
It is certainly possible to profit from WHX. But it is a lot easier to lose, even when you think you are winning.
How to Change The Game
A lot of people have wondered how WHX can stay above its fair value for so long, assuming it was groups 1-3 above. They are correct, but it's more involved than they may think. As long as investors are willing to hold WHX at these elevated prices in a non-margin account and limit units available for shorts to borrow, or miss out on the loan value in a margin account, hoping to get out before it drops again, leading others to buy expensive puts and others to short at high borrow rates, the opaque loan interest rate will stay high, put option prices will stay high, and value will continue to be lost to brokers and large investors. At this rate, more value from WHX will be lost in the stock loan market to brokers and large sophisticated investors than the remaining WHX distributions. This is how it CAN be profitable to hold WHX at these prices! But only if you are the house at the casino (the broker), or the king among peasants (large sophisticated investor).
I Call For a Revolution!
The only way to change the game to equal footing for the small investor is to understand the whole picture and allow the price of WHX to settle at its real underlying value of $2.42. Shorts would back out at this price. Units would be available to borrow. The loan/borrow rate would finally come down to less than 1% like most other securities (e.g., WHZ, which is fairly valued). Puts would be fairly priced with calls. The brokers and large investors would stop making out like bandits.
As the Pogo comic strip once stated:
We have met the enemy and he is us.