Ted Barac

Hedge fund manager, long-term horizon, deep value
Ted Barac
Hedge fund manager, long-term horizon, deep value
Contributor since: 2012
Company: Barac Capital Management, LLC
Thanks, Munger fan. Is that the unsecured note covenant that you're referencing? The senior secured lenders (1st and 2nd lien) should have their own covenants (which are the ones that could likely restrict buybacks of the debt junior to them).
If needed, the company could potentially get waivers, but the senior secured lenders often want the borrower’s assets to remain within the lending group (i.e. they don’t want any cash paid out to the subordinated creditors) as the priority position of a senior lender has little benefit if the borrower can deplete the assets (which are securing the debt of the senior lender) by repurchasing the debt of subordinated creditors.
In other words, they are often more concerned with leverage levels through their seniority/creditor-class than they are with total leverage -- particularly if their debt is also trading at a large discount and recovery versus long-term income/yield becomes the focus.
I have little knowledge of this situation, but just some thoughts to consider. There will be many institutional distressed debt specialist pouring over these documents and trading the debt (and equity) accordingly and because of the specialized legal intricacies of these situations, the informational disadvantage for retail investors in distressed situations can be large.
That's not to say that there aren't inefficiencies with distressed securities (or that retail investors can't find them)....it's just more difficult.
In situations like these, the covenants of the senior secured lenders often have "restricted payment" and "asset sale" covenants that can substantially limit the ability of a company to buy back the debt of the more junior lenders (e.g. senior unsecured lenders). Do you now how much capacity BTU has under their covenants to make these types of debt repurchases?
As your chart shows, historic earnings growth has little correlation with P/E multiples (which is logical because they are backwards-looking earning's growth numbers). I believe, however, that you'll find that forward earnings growth expectations (which is what is of more interest and relevance to the market) are highly correlated with P/E multiples. While all single ratios have flaws and should never be looked at in isolation, I believe that the P/E ratio is still one of the best snapshot valuation tools that there is.
The fact that companies with historically higher ROIC have higher EV/invested capital ratios makes sense, but it only provides a historical report card and does nothing with respect to providing a useful valuation for evaluating current market prices relative to forward earnings and cash flow expectations. What valuation metric would you advocate...would ROIC be in the numerator or the denominator and what would be at the other end of the equation? Let us know and I'm sure we can come up with a number of flaws with that ratio, too (as with all ratios) :)
Great article, Terrier!
The backing out of stock-based compensation is primarily of use for bond (and other credit) investors -- who are more focused on cash flow and don't care about dilution (in fact, they welcome share issuance and equity dilution).
For equity investors, backing out share-based compensation doesn't make much sense (and since Wayfair has no debt, it makes less sense for them to make this adjustment). That said, if their comps. have debt and use this number, it may be useful for comparison purposes across the industry.
In any event, this is very common and investors are not as stupid as some people may think (in aggregate). While a company may focus on this adjusted EBITDA number, the market knows what's going on and isn't confusing "adjusted EBITDA" with actual earnings.
Correct me if I'm wrong (I went through this quickly and haven't looked at the name in a while), but I don't believe that the PIK debt is convertible (the warrants are separate instruments which are accounted for separately) and the 2015 converts have a strike of $50/share and, therefore, also aren't included in the 356mn in fully-diluted shares.
So, I think your looking at a fully-diluted enterprise value of more like $1.6bn: $1bn in net debt + $748mn in equity (356 fully-diluted shares * $2.1) less $114mn in cash from the exercise of the warrants (114mn warrants @ $1/share) as assumed in the full dilution. Unlike the warrants, there would be no cash received from the conversion of the prefs.
So, using $140mn in 2015 EBITDA gets you to an EV/EBITDA of 11.67x on a fully-diluted basis.
Again, please correct me if I missed or miscalculated something here.
"An index comprised of universe B would also have a price/FFO of 20..."
No, actually, a universe of one company with a P/FFO of 35x and another of 5x would have a P/FFO of 8.75x. I believe that the index doesn't average the multiples, like you did, but takes the aggregate Market Cap./Aggregate FFO (unless this is different for REIT indexes?):
Let's assume company C and D are equally weighted (as your example seems to assume) at $100:
Company C: Price (Market Cap.): $100, (Implied) FFO: $2.86x, P/FFO: 35x
Company D: Price (market Cap.): $100,(Implied) FFO: $20.0x, P/FFO: 5x
Universe B: Price (Market Cap.): $200, (Implied)FFO: $22.85, P/FFO: 8.75
I agree that risk doesn't equal volatility, but I struggle to see how this security exploits that misconception. XIV trades based on actual option-implied expectations for volatility, not based on a desire by different counter-parties to "own or avoid volatility" and resultant supply and demand considerations.
In fact, one can wish to avoid volatility and equate it to risk while expecting future volatility expectations to decline (thus, being directionally bullish on XIV). Conversely, one can not care about volatility and not associate it with risk, but still expect future volatility expectations to increase (thus, not wanting to own this security).
If you want to exploit counter-parties that are volatility-averse, buy volatile stocks that are priced at a discount for that reason. Buying this ETN is making a directional bet on actual option-implied volatility expectations.
Thanks for the article.
I believe that the real issue is that the leasing model capitalizes the costs of the handsets (and depreciates them over time), whereas the non-leasing model expenses them as a cost of product. As such, the handset expense doesn't get captured by EBITDA like it did before.
Look at Sprint's recent quarterly results, for example. Equipment revenues declined by only $116mn (year-over-year) while cost of product decreased by a whopping $793mn (and depreciation increased by $373). As you can see, on a relative basis (when comparing to prior quarters), EBITDA is flattered by the shift to leasing and the resultant shift of handset expenses from cost of product to depreciation.
Fantastic article, Thomas! Thanks, so much.
"RS didn't say that $5/shr was a 'floor' or that $5/shr was the lowest it could go. He said that $5 was the most you could lose. Friday, it closed @ $5.01 so if it goes to $0.00 the most you've lost is $5.01/shr. Get it?"
So, in other words, your downside is limited to a 100% loss.
Thanks for the article. A few questions:
1.) Stoppelman has about $300mn tied up in Yelp shares. In such situations, it's perfectly normal for CEO/founders set up programs to periodically sell some of their options/shares over time. I think that many would consider that to be common sense diversification and not bearishness -- plus Stoppelman has a salary of $1.00 (one dollar), so he probably wants some periodic cash flow. Do you always view CEO/founder sales like this as bearish or is there something specific to Yelp's situation that makes you view it as such?
2.) Not sure I understand the point of your comparisons. The Clippers had revenue of $146mn last season while Yelp had revenue of $377mn last year (and I don't think the Clippers are expecting 50%+ revenue growth this year like Yelp). Similarly, Denny's and Krispy Kreme (combined) don't seem like obvious bargains to me, relative to Yelp, when looking at prior financials and forward growth rates. Why do you view these comps as examples of Yelp's overvaluation?
3.) "Billion Dollar Bully" is a "Kickstarter" project that has raised less than $100k (through Kickstarter) to produce the film. With all the haters against Yelp, you would expect that they could have raised more, no? The way some bears talk about it, you would think that it was a Spielberg production. Also bear in mind (no pun intended) that the allegations in the documentary appear to have been discredited already by the F.T.C., the court system, and a Harvard Business School study. All things considered, why do you put so much weight on this documentary?
Don't get me wrong, there are many risks with Yelp and many reasons to be cautious (as a lot of growth is still built into the stock price and there's a lot of uncertainty as to how their business model will work over the long term). That said, I don't think that Stoppelman selling shares, or the Clippers/Denny's/Krispy Kreme relative valuation comparisons, or the "Billion Dollar Bully" documentary are good reasons for bearishness.
You are right that investors should have foreseen those bubbles, but the fact is that many didn't (hence why tech and housing prices kept going up for years after they became overvalued). Investors (wrongly) justified the new prices. For tech stocks, it was a common belief that there was a new paradigm and the internet made old valuation methods obsolete. For housing, it was a common belief that, while growth may slow, real estate prices would always go up. Many held onto those beliefs through greed or impatience (after seeing prior bullish views never materialize over years...some losing fortunes shorting when valuations were way too high, but well before the corrections occurred). Worse yet (far from selling out before the price implosions) many capitulated and sold at the worst time (when prices actually became attractive).
If you predicted the bubbles correctly, you were eventually well rewarded but it was a lonely time from '97 to '00 for tech bears and '04 to '08 for housing bears (I was both). In fact, portfolio managers lost jobs for not chasing the overvaluations and (temporarily) under-performing the indexes. Wall Street isn't known for its patience.
Let's move on to today and make some forward-looking (rather than the very easy backward-looking) views. Take a look at this chart of 10-year Treasury yields (below). Looks similar to the bubble charts that you showed. Are you seeing a bubble now in Treasuries? Did you see one in 1987 when yields fell to 7% (after being at over 15% in 1981)? They kept falling for almost another 20 years (so far) from there. Is this an obvious bubble now or is their a "new paradigm" where low inflation and even lower European sovereign yields will anchor lower rates for the foreseeable future? Many (again) see a new paradigm. What say you (I say another bubble)?
Contact a tax expert (I'm not one), but if it's a minor child and you control their account, I think it could be considered a "related party" and the loss would also be disallowed.
"Selling a loser in a taxable account and buying it back in a retirement account avoids wash sale."
Not true. "The IRS has ruled (Rev. Rul. 2008-5) that when an individual sells stock or securities for a loss and causes his or her IRA or Roth IRA to buy substantially identical stock or securities within 30 days before or after the sale, the loss on the sale is disallowed under section 1091 and the individual's basis in the IRA or Roth IRA is not increased by virtue of section 1091(d)."
"I'm talking only about taxable accounts and whether it's better to pay tax today on a dividend, or tax on capital gain in the future."
Alex, your example on deferment still makes no sense. In example 1, you pay taxes on the $100k starting capital and all income derived from that $100k (deferred/paid in year 10). In example 2, you only pay taxes on your $100k starting capital (paid in year one) and then enjoy tax free earnings on the annual income from the residual $65k over the next ten years. Of course the deferment benefit is negated if you make up such a favorable (yet unrealistic) tax-free alternative scenario. Just because you pay taxes on something doesn't mean you don't have to then pay taxes on the income subsequently derived from the returns on that residual (after-tax) capital.
As I laid out before, here's how the math for the two examples would work in real life:
Deferred: $100 earning 10%/year for 10 years grosses you $159.37 in income. You only pay taxes on the income ($159.37) at year 10 (you taxed the whole balance - including your $100 cost basis -- in your example). At a 35% tax rate you net $103.59 in income, giving you an ending balance of $203.59.

Non-deferred: $100 earning 10%/year would net you 6.5%/year in earnings after taxes (using the same 35% tax rate). Compounding these earnings over ten years you would earn you $87.71, giving you an ending balance of $187.71.

So, the deferment nets you $15.88 more (off of the $100 investment). This intuitively makes sense as you are getting returns on the deferred taxes (over the 10 year period) in the first example and you are not doing so in the second.
Your examples are not really relevant to how taxation works in real life. A true life comparison would be as follows:
Deferred: $100 earning 10%/year for 10 years grosses you $159.37 in income. You only pay taxes on the income ($159.37) at year 10 (you taxed the whole balance - including your $100 cost basis -- in your example). At a 35% tax rate you net $103.59 in income, giving you an ending balance of $203.59.
Non-deferred: $100 earning 10%/year would net you 6.5%/year in earnings after taxes (using the same 35% tax rate). Compounding these earnings over ten years you would earn you $87.71, giving you an ending balance of $187.71.
So, the deferment nets you $15.88 more (off of the $100 investment). This intuitively makes sense as you are getting returns on the deferred taxes (over the 10 year period) in the first example and you are not doing so in the second.
Also, these examples don't even factor in the fact that your tax rate on the long-term capital gains in example one (15%) might be lower than what you are taxed on the dividends in example two.
Thanks for the article, Michael. Just a couple points:
I think you're overly focused on goodwill (which is a non-issue in my opinion). If a company sees value in Yelp, I don't think that goodwill is going to be a key consideration for a couple of reasons:
1.) If they see value, they don't expect a write-down.
2.) Even if the acquisition is a failure, the goodwill issue (in-and-of-itself) isn't that big of a deal. A write-down obviously is never desirable (as it means that the acquisition was a dud), but analysts normalize earnings for valuation purposes and throw these one-off items out of the equation (as they are focused on future cash flows, which aren't impacted by a write-down). A failed acquisition of a tangible-asset-heavy (at acquisition) company can be equally undesirable.
Also, I think you need to consider what the market considers a high EV/revenue multiple (look at the market comps) and not rely on your personal view (which only tells us that you aren't a likely acquirer).
My view from a few weeks ago:
Serenity, with all dues respect, you seem to be having a problem with logic in these discussions. Buffett likes A = Buffet only likes A.
Exactly my point, serenity! In light of the quote that you just referenced, I hope you can now understand the point that Buffett's statement:
"Diversification is protection against ignorance. It makes little sense if you know what you are doing".
shouldn't be taken literally, as I believe that his meaning was that you shouldn't OVER diversify. Taking the quote literally (as you originally endorsed doing) could be very dangerous.
I agree and I'm a huge fan of Graham. Like Buffett, however, I believe that you can also find value opportunities (securities trading well below their intrinsic or expected value) and pricing inefficiencies in investments beyond those found within the guidelines of Graham. I suspect that Graham would also agree that his guidelines are general and aren't meant to be all inclusive -- i.e. capturing ALL attractive investment opportunities.
You seem to think that Buffett follows Graham's advice to the letter, but then you say to take Buffett's quote about diversifying literally. That would put him in stark disagreement with Graham, who was a huge proponent of diversifying.
Oversimplify and take the quotes literally at your own risk, Serenity. I think that you will find that Buffett's investment criteria goes well beyond that of the traditional Graham methodology (though that's clearly a huge component of it).
Buffett has shown to be attracted to mispriced securities of different kinds (not just the traditional ownership of undervalued businesses with a high margin of safety). For example, he sold billions in options (puts) on both junk bonds and the equity indices because he believed that they were mispriced. He also recently said that he would short long-term bonds if there was an easy way to do so and he could do it in scale that made sense for him (does that fit into what you believe Buffett's value investng is about?).
If you think Buffett wouldn't put money into an investment that he believed had a 45% chance of quadrupling and a 55% chance of losss of principal (an investment most likely to produce a loss and to go against "rules number 1 and 2"), I don't think understand him as well as you think that you do. That security would be severely mispriced and trading substantially below its intrinsic value (though the most likely outcome of investing in it would be a loss).
Oversimplifying complex issues is easy, but not always wise.
I really don't get the attractiveness of LVLT here. If they meet your expectations over the next 4.5 plus years, then they grow into their lofty valuation (at over 7.0x 2019 EV/EBITDA and almost 2.8x 2019 EV/revenues, based on your estimates). If they don't, the downside could be huge. Risk/reward seems horrible to me at these levels.
That said, I've believed this for a while and the market has strongly disagreed with me, so far.
I would be inflationary because it increases the money supply. Think of it this way, $100bn of QE increases the money supply by $100bn while reducing the financial assets available for purchase in the markets by $100bn.
Let's just leave it at that. If you want to believe that QE doesn't increase the money supply and/or, that an increase in the money supply can't have inflationary effects (granted, it's also dependent on the velocity of money and other factors), then that's fine. It doesn't appear that I'm going to be able to convince you otherwise.
I think you responded to the wrong comment, Colin. I said nothing about stock prices or the stock market. I was talking about the impact of QE on the money supply.
You seem to be confused by the fact that the money that's being created by the Fed is used to buy financial assets (and not just given away). That only means there is no increase in wealth for the private sector (you are right that it is just an asset swap for the banks). However, since the money used to buy the bonds was created, there is an increase in the money supply.
Buffett didn't leave billions in the table because of "macro misunderstanding". Not timing the peak of a bubble shouldn't be confused with being wrong. In 1998 and 1999, people also accused Buffet of "being wrong" about the value of internet stocks. I believe this call on interest rates will end the same.
Buffett understands Q.E. just fine. Yes, it is just an "asset swap" but the cash used to buy the bonds is created and increases the Fed's balance sheet (and the money supply). Do you not believe this to be true?
Mark_A, it's also interesting to think what would have happened if some unforeseeable catastrophe (e.g. undetectable accounting fraud) subsequently occurred with Buffett's (40% concentration) AMEX investment (always a possibility, no matter how small).
What if a very unlikely tail risk event occurred and he lost all 40% of his capital (plus never obtained the massive returns that AMEX delivered for him).
How would his long-term track record have been impacted? Did that highly concentrated investment put him just one black swan event away from never being considered "The Oracle of Omaha"?
Very interesting. Thanks, Mark_A. I would recommend diversification (to a degree) for 100% of investors but, again, it's a relative term.
Thanks, again, for the comments and info.
I guess it depends on your definition of diversifying (as it's a relative term). What data brings you to the conclusion that Buffett "did not start off diversifying"? In other words, how many positions did he hold at the time that you're referencing and what was his largest (in percentage terms)? If not the exact figures, then just the general levels of concentration.
"Perhaps, "my portfolio of the toilet paper maker has 'organic' income, the other guy's income is 'inorganic'" as some other might suggest. 'Organic' income goes with the green movement."
That eloquent quite sounds familiar, Varan. Another Buffett one?
Thanks, Nicholas!