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Rena Sherbill: CashFlow Hunter, welcome back to the show. Always great to have you on Seeking Alpha. So thanks for coming back on.
CashFlow Hunter: Always great to be here. Thank you for having me.
RS: Absolutely. So, last time we had you on with Brett Ashcroft Green talking about 3M (MMM) and laying out the different sides of the investing thesis there, and there was some news immediately after that was released.
I'd love it if you would, and there's been more coming out, I'd love it if you would catch listeners up on 3M. And how you're thinking about them? And how it looks in terms of investing and just the general picture there?
CH: Sure. So, I'll preface this with - some of this is my opinion and then some of this is -- clearly is, very much fact. And I think the fact is -- the facts are actually going to be way outweighing the opinion to the negative for the company. So, I don't remember what we last spoke about, whether there was going to be -- whether it was pre-PFAS settlement, I believe it was.
RS: It was just before. Yeah. It was just before.
CH: Okay. So, all right. So the company has had two settlements, in the past, let's call it the two months, 3 Months. One was for the municipal water multidistrict litigation, where you had something in the – to the order of like 3,000 municipal water districts that their cases were linked.
And they settled for the remediation of PFAS pollution to what the company agreed to was between $10.5 billion and $12 billion and up to $12.3 billion, where about I have to go back and look at what the terms of the settlement are, but it was something to the order of $5 billion or $6 billion of the $10.5 billion would be paid in the next 3 to 4 years, lump payments made.
So something like $1.5 billion to $2.5 billion per year depending on the year. And then the tail payments would be paid out over, I think it was something another 8 years to 10 years. And if there was an overage over the $10.5 billion, it could go up to $12.3 billion.
And I'll start with that first. Actually, no, let me go and then they just had an earplug settlement, with the veterans who had hearing damage, and they – it was a tentative settlement on that for $5.5 billion. And that is on the -- both settlements actually are on the low end of the -- of what a lot of people were expecting in terms of what the company's liability would be. And I believe the -- it's $5.5 billion for the ear plugs, paid out over five years. So let's assume $1.1 billion per year. So that is one set of facts that’s out there.
In my opinion, the lawyers for both classes, if you look at who they are, they're incredibly unimpressive academically. You see, you have a lot of guys who certainly did not go to the top law schools, who are the heads of their own firms. And I think what a lot of people would effectually -- un-effectually, refer to as ambulance chasers.
I think lawyers, plaintiff’s attorneys, and again this is purely my opinion, I'm not denigrating anybody, I'm not intending to denigrate anybody, but, plaintiff's attorneys are generally going to look for settlements rather than try to get the most for their clients. Because if you can get a settlement, particularly from a large company, then the lawyers are kind of guaranteed payments in a guaranteed timeframe.
So in the case of a $10.5 billion settlement where you have $5 billion, $6 billion paid out over three or four years, if you have plaintiff's attorneys who have a standard contingency payment structure, they get a third of that and they'll get paid definitively over that time frame. Same thing with the $5.5 billion from the air plugs. Well, that's all fine and good.
But the indications from previous – from trials of individual cases from people who either had the hearing damage, or there is actually no trial for PFAS pollution damage, but the indications were the settlement -- the costs were going to be much higher. Look. And the lawyers would have to do a lot of work, a) to try those cases and, b) then the company could appeal it and it would be a multi-year process.
Ultimately, I think the people, their clients would get significantly more money if they went the trial route. But the lawyers would have to work significantly harder and they would get their payments at a significantly longer timeframe. So, in my opinion, I do not believe that the lawyers came even close to negotiating the best possible deal for their clients.
In the case of the water districts, 22 state attorney generals seem to agree with me that the settlement that the multidistrict litigation lawyers negotiated was not acceptable. And the reason – so if you think about it, the average water utility district is not a very big organization. It is certainly not supposed to be a major profit center.
And so they don't have big legal departments, but more importantly, they don't - management doesn't - of those things doesn't necessarily care if they get everything they're supposed to be getting from 3M to clean up the pollution, because if they get a settlement and it turns out to be insufficient to clean up, to remediate the water pollution, who pays the overage.
Is the ratepayers. It's taxpayers who pay the overage. So they're sort of not necessarily incentivized to get everything that they should get or need to get from the company to clean up the pollution. And so the state attorney generals, 22 of them said -- called BS on that settlement, and they said, look, you didn't negotiate, this is not going to be -- probably not going be enough to clean up these water pollution and you're going to end – 3M, the people holding the bag, if it's not enough are going be our taxpayers, our ratepayers. So we're not going to accept this.
So the same day or I think it was the day after this 3M -- the earplug settlement was announced, the terms of the settlement for at least the Attorney General of New York State agreed to, and I'm assuming she agreed to the same settlement as the other 21 attorney generals who were blocking the PFAS settlement, came out and it said that the amount that 3M is going to have to pay is for just the water utility pollution, is now uncapped.
So it's not just a $10.5 billion to $12.3 billion settlement. It, in my opinion, it reads that it's a $10.5 billion minimum settlement and whatever the pollution - costs of pollution, whatever remediation for the pollution costs, it costs, there is not a cap. So that's a fact now.
And it's weird that the details of that settlement came out the day after the ear plugs came out, and it seemed to get, sort of ignored or buried. And so I think that that is a material negative for the company. And that, yeah, okay, yeah, you might get away with $10.5 billion. But that’s now at least what you have to pay and it could be significantly more.
And no one asked the company about that on conference calls or anything like that. And I will also come back to the fact that this is still – the water utility suit is just one of the PFAS liabilities. There is still property damage, personal injury. The state attorney generals are still suing these guys. That wasn't -- the state attorney generals just came in and sued to alter the water utility district.
There are still other suits for pollution within these individual states that are still being, that the company is being sued for. And then again, you still have the EPA.
So long winded answer. The earplug settlement, maybe it goes through. I always thought earplugs was going to be small compared to PFAS. I'm not going to get really excited if the company got away with a $5.5 billion settlement, instead of a $10 billion settlement.
The delta is $4.5 billion in the context of a potentially north of $30 billion liability for PFAS. The earplug - that difference of what they have to pay out for the earplugs is really not all that material, in my opinion.
Although I will say now that over the next 3 to 5 years, the company is going to be paying out $3.5 billion, or more, or somewhere around there, $3 billion to $3.5 billion in just these two settlements, just they were agreed upon payments. And that wipes out -- certainly that is equal to what the company has been paying out in dividends. And all of a sudden the dividends are definitively nowhere close to being covered by free cash flow.
RS: Right and that’s something that's been discussed. The notion of the vitality of their dividend and what these settlements are going to look like. On the bullish side, I think some people think, or are saying that the settlement, the fact that it's been quantified, okay, we can move on. But I think what you're saying is, we cannot move on because we haven't exactly quantified it yet.
CH: Well, you've quantified it for – you have quantified it potentially assuming the settlement goes through and for ear plugs...
CH: …and you have a high enough participation rate. I think the threshold they said for the deal to be fully blessed or go into effect is that 98% of the plaintiffs have to agree to that, to getting what they're going to get. And look, I mean, if you’re saying that there are, let's say there are 250,000 plaintiffs here. And you're agreeing to a $5.5 billion settlement.
It's around $21,000 or something. $22,000 per plaintiff. After the lawyers take their third, you're talking about a pre-tax payment to somebody who lost their hearing of $14,000 to $15,000. I don't know if those people are necessarily going to accept that. And they need to get 98% of participation for that agreement to go in effect.
But what I think the only thing that's truly quantified here on the PFAS is the minimum that they're going to have to pay. And I think, a) that the payment for the water utility district pollution could be significantly higher than that minimum. And b) it's -- the water utility liability is still just, in my opinion, a small part of what the ultimate dollar liability will be for PFAS.
CH: I think it's only, there's nothing but bad news coming down the pike for the dividend.
The company seems intent on spinning out the healthcare division. As far as I can tell, that's about $2.5 billion of the $8 billion of EBITDA the company has. And I think it is some of the highest cash realization EBITDA that the company has. So the healthcare division is going to be paying, you know, I think the plan is a $6.5 billion to $7.5 billion dividend to the company.
And then the company will retain 20% ownership of the healthcare division. And so they'll be selling that. Between that payment and the residual stake in the healthcare division that they will then monetize. They will perhaps use that as to fund a dividend. But in my opinion, they will use the event of the spinoff of the healthcare division to reset the dividend for going forward.
Frankly I think the $6.5 billion or $7.5 billion dividend that they're going to get from the healthcare division and the state of healthcare division that they'll sell down. And that’s just going to go to potentially funding the liabilities of just what they've settled from PFAS and the earplugs. The existing dividend they have per share of the current 3M will not be sustainable. There is a question of whether the healthcare spin will also pay a dividend.
My guess is that it will not, or it will not pay a very large dividend because look, they're spinning it out with about 3 turns of leverage. And they aren't, I guess the strategy is to use that business as sort of a base business that they'll be acquiring other assets or other healthcare businesses with. And you're not going to be able to do that if you pay out - spending out with 3x leverage and still paying a dividend, a big dividend.
So net-net, I think whatever, is it a $1.50 per quarter or something like that that the current shareholders are getting from 3M, I think that that $1.50 whether it comes in remaining 3M shares, or the healthcare shares, the total cash that they'll be getting will be lower and the company will use the spin out as the catalyst to ultimately cut the dividend.
RS: What do you think about that decision to do the spinoff?
CH: I don't understand how - in my opinion, it sort of fits the definition of fraudulent conveyance. You're taking value out of an entity that could be used to satisfy future plaintiffs from PFAS. That's, in my opinion, it strikes me as a potential fraudulent conveyance action that the company could get sued upon about for in the next subsequent years, but the company seems intent on doing it. And they have, I'm sure, pretty expensive lawyers who are telling them they can.
They are counting on getting quite a big multiple it seems for the healthcare business and I'm not quite sure why it would get a big multiple. The healthcare division’s organic revenue has been pretty lousy for the past couple of quarters. I think the -- maybe we're talking about really low single digits at best organic revenue growth.
And so typically companies with, flat to maybe 1% to 2% organic revenue growth, don't capture big EBITDA multiples. Maybe they will be catching -- maybe they're in some sort of cyclical low. The company has never really explained that that is the case, very convincingly in my opinion.
And so I suppose the healthcare division will trade at a higher EBITDA multiple than the consolidated 3M trades at, but I don't suspect it'll trade at where the company needs it to trade for there to be major value creation from the spin in my opinion. And I walked through the math on that in my first article on 3M that I wrote sometime in May.
RS: So, are you still short the stock? 3M.
CH: Yeah. I have a short position via derivatives in the stock. And I still think that the credit is a relatively easy short.
RS: Would you advise investors in terms of -- you talked about how to short stocks with Kirk Spano…
RS: ..a few months ago. How would you advise investors with 3M right now?
CH: So, I think if you want to just, with any short, but particularly for 3M, if you want to cap your potential downside, which means upside to the stock, you buy longer dated puts, the company still doesn't trade with particularly high volatility.
So longer dated puts are not particularly expensive and the events that are going to do damage to the valuation for 3M they are – there is a – somewhat of a definitive timeline now. The EPA should be, the spin out should be happening before the year end. They're trying to get it done by year end. And I think that the dividend cut will probably come somewhere in the fourth quarter, if not the first quarter.
So you can buy puts that are not that far out of the money for say, January or April of 2024 expiry. The implied volatility is 26 which is pretty low. That means that you have a pretty -- you're not going to have much -- it's not going be very expensive to buy, say 95 strike or somewhere in that neighborhood puts for January or April of next year.
And you don't need a very big move in the stock for those puts to pay-off pretty handsomely. And April is actually -- may be the sweet spot because you could potentially capture the dividend cut, continued weakness in the core business. And then I believe the EPA should be getting their hazardous material designation for PFAS sometime in the first quarter of 2024.
If not, if you just want to be short the stock, you can be short the stock even when you have this potentially great news from the settlement from the earplugs, the stock went from 98 to a high 99 really to 107. So, yeah, it kind of stinks to have something go up in your face 8%. But it's not like a GameStop (GME) situation from two years ago where – or two and a half years ago where the stock went up 20-fold, that’s not going to happen with 3M.
And you can also mitigate some of your potential downside in the puts, being short of the stock, you can sell some covered puts, basically you sell lower strike puts in addition to your short, most brokerages will allow you to do that. And that just -- if the stock cracks, your puts are going to get exercised but your shorts have come down. So you'll make a little -- you'll make some money on that trade. And if the stock doesn't go anywhere, the premium you take in from selling the puts helps offset the cost of the short.
RS: Can you envision any catalysts to the positive side that would make you rethink or adjust your bearish take on 3M?
CH: Yeah, you always have to be -- you always have to think about that – with shorts is what could really tag you. And the major downside would, a) be a successful spin of the healthcare business where the healthcare business trades at some big multiple and the stock really takes off.
I think a lot of people are hopeful that GE HealthCare which was spun out of (GE), sometime in late 2022 I believe, and that stock got spun out at, I think it was around $60 a share. By April, the stock was close to $90. So it’s a 50% move higher in that spin out. This is a big enough business potentially that if it gets spun out and trades up 50% that would hurt the shares.
But you don't have to be short -- if there's a spin out and you don't want to be short the healthcare business, you can just cover the shares that you're short via the – in healthcare business.
I'll also add by the way that GE HealthCare stock has come way back down, and is only trading at about a 10x to 11x EBITDA multiple. If the 3M healthcare business only gets a 10x EBITDA multiple, that’s going to be considered a major, major disappointment. I think from all the -- everything I’ve read is people are thinking that the company will get spun out at a 12x multiple and potentially trade up to 15x. So 10x is like a disaster. And by the way that would actually be a net negative to where the stock is right now.
And then obviously another -- what can make the stock work on the bullish side would be some sort of broad settlement for all of their PFAS liabilities, covering all their personal injury, all their property damage, all the state attorney general suits. And then the EPA not getting hazardous material designation for PFAS and the EPA saying, okay, well, you don't owe the federal government anything. There's not going to be any super fund liabilities here, which again, I find highly unlikely but anything's possible.
CH: Yeah. That one’s been super interesting.
RS: Yeah. Get into it. Let's hear.
CH: Look, I forget where the stock was when Kirk and I spoke.
RS: It was in May. End of May. May 23rd.
CH: May 23rd. Okay. So the stock was at $4.67. And I had originally written about the stock when it was about $3.73, I believe. So, it already had a little bit of a move. The stock caught a really nice bid up to $8 which I thought, a) it certainly gave people a trading opportunity. It then fell back down to, right around where it was when we first had our discussion. So it's right back to like that $4.67 level.
But what's become very interesting for the company, couple of things. One, Bitcoin had a nice move higher and that is probably – and all Bitcoin related stocks had a huge move. Even the companies that had, in my opinion are terrible business models that make no sense like Coinbase (COIN) or MicroStrategy (MSTR), all the six moved up. And Iris caught part of that tailwind and then moved up with Bitcoin.
But what has happened since is twofold. One, well the company is going to be reporting earnings, I believe on the 13th. They released monthly operational updates. They've been increasing their exit hash rate and they are -- but the most recent disclosure was super interesting. It showed the strength of their renewable power component. They have a renewable power PPA in place in their Texas facility.
So cheap energy and I don't know if you're aware, but Texas has had major energy shortages. So the company actually disclosed this past week that they had a negative energy cost for the month of August, which means that they either -- whatever they were -- either they use, they use the energy that they use for mining Bitcoin, and the excess energy that they had, they sold into the grid and they ended up with a negative cost of energy.
And I am not -- it's not entirely clear to me if that meant that they still mined Bitcoin or they didn't mine Bitcoins, and they just sold all the power they had to the grid because it was more profitable to do that. Whatever they did, I'm sure they maximized the cash flows. So that's just, that's just interesting in and of itself.
What's also - what's another leg that I think is fascinating and I wrote about this in an update about Iris is they also announced that they purchased about 100 microchips from NVIDIA (NVDA) for about -- it was $10 million. I think they bought 240 microchips. Numbers are maybe a little different. But anyway, the important thing is that that basically puts them into the high performance computing data center business, which is just, that's a big multiple business, it's a big growth prospect business.
And it is something that is way different than the other Bitcoin miners. So look they have these state of the art facilities that have cheap power. And so, instead of being just a Bitcoin miner, which is potentially a business -- which is definitively a business where you're dependent upon the price of Bitcoin for your profitability. They all of a sudden have an angle where they can get it, be in the data center business for high performance computing and AI, which is going to be a really nice growth area and is the growth story for the data center industry right now.
And it was actually really interesting because I went to a conference, Piper Sandler hosted a macro conference this past week, and Jim Chanos was one of the panelists. And he was ascribing how he is short data centers, and the reason he is short data centers is, he said, look everyone thinks that AI and high performance computing is going to be great for the entire data center industry. And he said, look, there is going to be some data centers that are -- that's going to be huge boom forth.
And he didn't mention Iris, but it seems to me, Iris is going to be one of those companies. And he said, actually if you look at most data center operators, AI and high performance computing are major negatives because their existing facilities are not equipped to handle the energy needs, or just the cooling needs or the centers are not designed for AI, or high performance computing.
So they're going to have to spend a lot to get those facilities up to snuff. And I thought that was really, really interesting. So not only is Iris beautifully positioned to have this AI high performance computing growth angle and which sets them apart from other Bitcoin miners and everyone and other people in the Bitcoin space. It actually -- they're not just going to be in the data center business, they might be one of the best performers in the data industry -- data center industry which either the stock should react on its own from that, or it makes them a potential take out candidate by other data center operators.
RS: Were you surprised by the announcement with NVIDIA? Were you impressed? Did you see it coming? What did you think about it?
CH: Well, I’ve written about -- the company has been discussing that? I said, look, if Bitcoin doesn't work for us or even if it does work for us, we've still got spare capacity, we could get into this high performance computing AI sector really easily.
In fact the company had an agreement with Dell, or non-agreement or they had a -- they were negotiating with Dell, I think it was like two or three years ago and the negotiations never really materialized into anything great. But no, they've discussed this in the past and I wrote about it in my previous articles on Iris. And as a potential and it's a free option and the stock moved up nicely on the day of the announcement.
Although it's not entirely clear if it was that announcement with the NVIDIA purchase, or that was the same day that the SEC – the court found that Grayscale had the right to become an ETF. So everything in Bitcoin rallied that day, and it's subsequently fallen down. But look I don't think, the nice thing about Iris is, you're not paying -- you're paying a very low multiple of their Bitcoin mining profits right now for the current company.
And I think it's an even lower multiple than people really understand because of the cash flow that the company's been able to generate over since they last reported the balance sheet. If you look on Bloomberg, the company Bloomberg is showing that the company still has net debt of about $70 million. It actually has net cash as of May of $55 million. And I believe that cash balance has gone up, absent the money they spent to buy those NVIDIA chips.
So, the company look, I think right now you're only paying about 4x EBITDA for the core Bitcoin mining business, perhaps less. And you're getting this data center business for free. So I think there are a lot of reasons why the stock is sort of being overlooked. Potentially because it's listed on Australia and it's a relative small cap. But this is a very exciting story.
RS: Yeah, it's definitely. I think a theme of the Investing Experts Podcast in general and probably a theme of investing is, look for the disruptors and the disruptors are coming all the time. You think it's -- you think they're just disrupting one industry, but I think for a company to really have a successful vision and strategy, they need to be looking outside the box and I think this is a really nice example of that.
CH: Look, I agree. And I think it's just showing that if you have good core assets… they have good core assets. They have modern facilities with cheap power contracts and there's a lot you can do with that.
RS: Absolutely. So honestly towards the end of our conversations, I always feel like there's a whole other conversation to be had, but kind of keeping it in terms of catalyst hedge investing, how you're looking at the markets, how you're looking at sectors, what would you say to investors you feel like is a catalyst that you're looking at or thinking about?
CH: Well, so in terms of major positioning right now, I still think this PFAS thing is ugly and is going to continue to be ugly. I think Iris is a -- could be a long in a pair trade against other data center operators.
But macro wise, I think and I wrote about this for my subscribers this week. I think the regional banks are going to – those stocks potentially could have a problematic couple of months. Number one, I think earnings are going to be kind of lousy.
CH: Well, the shape of the rate curve, although it's less inverted than it was, is still pretty ugly. And they're going to -- and the cost of deposits is going to be pretty bad for them. So whereas they're not on this death march that a lot of banks were at, post-Silicon Valley (OTCPK:SIVBQ) where they were bleeding depositors and they had this big massive holes in their balance sheet, they seemed to have survived that run on the bank panic.
But their earnings profiles, at least from a net interest margin basis are going to be pretty bad and then you really start -- I think you're going to start potentially having some losses in their commercial real estate lending portfolios. So you have that.
So I think third quarter for the regional banks, they'll be reporting in, I guess it's going to be in about a month, sort of the third week of -- generally the third week of October.
And I think that the earnings results are going to be pretty bad and then while the stocks are off their lows, the (KRE), which is the regional banking ETF was down around $35 from $60. At the low point, it's back up to the low-40s.
I think that if the KRE, which is just representative of a basket of regional banks, if it's still down at these levels, come Thanksgiving, you're going to start having some year-end tax laws on, sort of across the regional banking space. I mean, why wouldn't you? Right.
So, I think that’s just a broader macro trade of a combination of bad earnings, bad earnings outlooks for the regional banks and then year-end tax loss selling. We saw some pretty violent year-end tax loss selling, pain in the tech space last year, in December. So that's a macro type trade.
And then one other thing I think a lot of people are seemingly ignoring, if you look at a long, long timelines of interest rates versus the S&P or NASDAQ, that earnings yield or earnings multiple versus interest rates generally was pretty correlated.
And we've had this massive divergence, pretty much since about March where S&P and NASDAQ particularly have -- their valuations have gone up a lot as interest rates have gone up. And that's a pretty big divergence from where the normal relationship is. And I think that's something, look that can persist for a while, but generally earnings are discounted, backed by some sort of interest rate and the higher interest rates go, typically you don't have earnings multiples go.
So I think that's something that people are clearly anticipating, interest rates coming back down fairly quickly. And this is actually something I've written about for both my subscribers and general Seeking Alpha, more for my subscribers.
But that most rhetoric coming out of the Fed is higher interest rates for longer, not necessarily the interest rates are going to go much higher, but that they're not going to be coming down any time soon. So, if the bet that you're owning stocks is because the Fed is going to be lowering interest rates aggressively next year, I think that's probably a, or potentially a -- not necessarily is going to materialize for you,
RS: The right bet?
RS: CashFlow Hunter really appreciate it. Always appreciate our conversations. And I think anyone who would agree with me that this is some pretty sharp thinking and savvy investing. You have a 14-day trial for Catalyst Hedge Investing. Anyone looking to become a subscriber or learn more about what you're talking about with subscribers really easy way to get some edification there.
CH: And they get access to me too.
RS: Hey, most important thing that there is.
CH: Whereas I don’t respond to just general messages anymore.
RS: Yeah. No, that's right. You don't have to just read or listen, you can actually engage. So, yeah, that's probably the number one selling point for sure. Always appreciate you, CashFlow Hunter. Thanks for taking the time.
CH: Thanks so much Rena.