Admiral Nemo

Value, debt, growth at reasonable price, bonds
Admiral Nemo
Value, debt, growth at reasonable price, bonds
Contributor since: 2012
It is positive news. There are a lot of (retail) speculators short stocks or buy puts just by a story or headline. But for these high dividend stocks, as long as the dividends stay viable, it is painful for short sellers. The implied vol is high, so short through puts is also expensive.
Mangrove saw the value of the assets in HLSS. But I don't think their proposal of cutting all relations with Ocwen at once is realistic. HLSS finances a big portion of Ocwen's non-agency MSRs. Ocwen is exiting agency mortgage servicing business. If HLSS transfers away most of the non-agency servicing. Ocwen will stop being a viable business. Mangrove's letter claimed that Ocwen would breach credit covenant only after the (massive) transfer and HLSS would not be impacted. This seems to be a wishful thinking. Creditors will not sit waiting HLSS takes away bulk of the MSR assets and leaves their debt at more risk. Ocwen could also take preemptive action if they foresee it happens. $31-40 per share is for an extreme optimistic scenario and needs market to put on a rich valuation on HLSS' assets. If Ocwen's counterparty risk recedes, I think a more realistic outcome is that HLSS share price trades back to book value ($18) or 15-30% above book value ($21-23) to reflect a premium on its MSR assets.
It is not the severity but the odds matters in that scenario. You need to take into account the assumptions underneath that $7 scenario: 1. ALL MSRs are terminated and transferred WITHOUT compensation to Ocwen. AND 2. Ocwen will not compensate HLSS.
Non-agency mortgage servicing capacity is not easy to build. Transfering MSRs in large scale is easy said than done. No matter their view on Ocwen, bond trustees need to consider who can take over the servicing without disrupting the cash flows and at what cost.
Ocwen is shedding its agency mortgage servicing and reducing the leverage.
I did not calculate the dividend yield in that scenario because it depends on how HLSS invest those proceeds from HSART and new operating cost structure. If they can find assets generating levered IRR of 15-20%, they can maintain a high single digit to low teen dividend yield to book.
They need capital to acquire more assets and grow. OCN offloads capital heavy assets (mostly MSR advances) to HLSS, which acts as its financing vehicle. HLSS does pay high dividend like a REIT. They are not registered as a REIT probably because MSR advances don't get REIT tax treatment in US. HLSS is domiciled in Cayman Island for tax reason.
Thanks for forwarding this news. It is very important to re-evaluate the revenue and profit outlook of NPK. My initial estimate of the acquisition size was based on the guessed DSE revenue of $20mm. Looks like DSE and its backlog are much larger than estimated. At first glance, I don't think NPK overpaid. The defense segment margin is over 20%. $187 revenue will bring in $37mm pretax profit for NPK in three years. The return on future contract shall justify the addition $10mm price paid. The large cash outlay may affect NPK's dividend payout though. I will do more detail analysis on the company.
I believe the customer base of their absorbent products segment is now reasonably diversified. The sales to Medline was 30% of the segment revenue in 2012, the last year of their relation. NPK's annual report mentioned that they have picked up several major distributors to make up that portion. So my guess is that no single customer contributes more than 20% of the segment's revenue now. The private label adult incontinence market is gaining momentum. Some retailer chains are large enough to make private label order economically viable. From what I learned, those chains include Walmart, Kmart, Rite-Aid and Shaw's. I don't know if NPK has any of them as their customer. But it seems they are aiming for it. The new equipment they ordered is to produce a new line of briefs in late 2013 and enable them to qualify for retailer bid.
In defense segment, outside of 40mm system contract, they are the subcontractor of other Army procurement. They produce fuze for General Dynamics. I think Army's change of heart may have something to do with the contractor's financial strength. DSE is much smaller than AMTEC. It probably lacks the balance sheet strength and the support from a parent company like NPK. But I agree that dependence on the Army is a concern. But they are doing the right thing to diversify into non-lethal weapon. It is also interesting that they moved ALS to Perry Florida and built a training facility there. So in long run they may get some revenue from service than manufacturing.
As for the cash flows, my base case projection for the next several years is in low $6 per share. I agree that the current share price is not super cheap. But it is not expensive either. My initial position is around $71. If it drops to $65-$67, I will add to my holdings. I want to own some shares now because there is a chance that the absorbent products segment surprises on the upside. They have just completed a major capex cycle and already picked up several large customers there. I doubt NPK will drop 33% in next recession. The defense budget is not much to do with the economy cycle and it is already projected toward the downside. Adult diaper is very much a demographic play, recession shall hardly make a dent there. Housewares segment is to certain extent counter-cyclical: people dine out less in a recession and spend more time cook at home (that segment had positive revenue growth in all years between 2007 and 2010). And more importantly, this company has no debt and carries good amount of cash plus positive free cash flows. A recession may be a good time they go shopping for assets or competitors at bargaining price.
If you look at the dividend per share history: 4.25 (2008) 5.55 (2009) 8.15 (2010) 8.25 (2011) 6 (2012) 6.5 (2013, accelerated paid in December 2012), it is more a dividend jump in 2010-11 than drop in 2012-13. 2012 dividend per share is still higher than in 2009 with a cagr of 2.6%. They were returning cash in 2010-11. The cash balance (cash & equivalent + marketable securities) peaked on 12/31/09 at $167mm. The dividend payout in excess of free cash flows was $2.34/share in 2010 and $1.89/share in 2011. Subtract these from the dividend per share numbers in 2010-11, you get a pretty smooth uptrend.
I think 2014 dividend will be somewhat flat to 2013, which is already paid. The capex will come down by then and it will help cash flows despite the pressure on the top line. The bottom line is that the growth in absorbent products segment will cushion the drop of defense revenue. 3-4 years down the road, the weight of absorbent segment in total revenue will grow to 25% or more.
Thanks for the compliment. Rather than following earnings, the purpose of two scenarios is to provide a range of valuation, which offers some clues of margin of safety. It also helps to identify and monitor those key drivers of the earnings (or more importantly, the cash flows).
Performance advantage is only meaningful if it can make significant difference in user experience or have sizable business implication. Mobile device users generally care less about what chips are used in their smartphones or tablets. For OEMs to switch, Intel needs more convincing value proposition. That is the reason I said that Intel faces a uphill battle in mobile business. The network effect from ARM's installed base is a big hurdle for Intel to clear. On the other hand, rapid growth can also make incumbent vulnerable as the new customers are less captivated. Intel's mobile chips is more likely to be adapted by the device makers in the emerging market, notably by Lenovo, which has barely presence in the smartphone market but now a significant player in China.