SharperDingaan

Racemize. Once the FBK saga is over we will do a multi-part thread on small cap investing using FBK as the example. There is no right or wrong to it, but it is definately not boring ;) SD

In terms of share count: > low 6 digit. In terms of $: Zero, as we are working with house money - having recovered our investment a few times over allready through the years. Ideally we would like to see a 10-20% increase in the offer price (high enough for face saving purposes, but not enough to trigger the FBK management options), & a material cash dividend (ABH/FBK synergies carrying the interest cost) When it's done, we would like to be able to exchange for &/or buy up to about double the ABH position that we would otherwise have got. We like foresty, but we need to move up the quality curve. SD

As long as ABH can buy the coy for less than its approximate MV, the offer will proceed, & we think there is +/- 220M on the table. The negotiation is about how much of that +/- 220M will go to FBK vs ABH shareholders. It is in FBK's interest, & power, to declare a special dividend as soon as possible - & make it as of record the day BEFORE the bid was made. Excludes all bid related selling, & ensures that original institutional shareholders get the cash - decapitating possible opposition. As the total dividend will still be less than the +/- 220M on the table, it will remain in the ABH interests to proceed. Most would also expect that the offer can still go through - & on the same terms - as FBK shareholders get the $1.00/share + the dividend. About the best that anyone can really hope for. And .... the improvement will be without ABH having to put ANY additional cash/equity. Keep in mind that the FBK debt covenants give them a sizeable exclusion (FBK managements Q3-2011 reason as to why they could claim a 12% D/E ratio). An additional 75M is the LEAST they could borrow, & this is BEFORE stripping all available cash out of the existing working capital. Notable is that the dividend is in the lock-up groups interest, as they will be recipients of the cash. Not reassuring the banks, or blessing the transaction, will hurt them as cash is better than ABH stock. Everyone walks away happy. Agreed; management may know to run mills, but s**k at creating value! It is beyond pathetic, that most of the opposition seem to have to come from a message board. SD

Like everyone else, we're happy we can get out ... but it will not be at 37c (130M/350M [assumed approximate market value]) on the $. We're sorry - but even a blind, & one-eyed monkey can do a lot better than this! This is hostile, lowball, "all or nothing" bid for the entire company - & highly likely to succeed. But there is NOTHING .... to prevent FBK borrowing every nickel it can on its credit lines (130M-150M) & paying out a 'special' div of $1.00/share before the close date. ABH may win, but it gets a sucked out shell - & 130M+ of additional debt! This pig is going to release its value - but the pie will be a lot bigger if the parties negotiate. Easy to change FBK's management if its a show-stopper. SD

Just to ensure that FBK 'gets' point (2) .... Per the Q3-2006 acquisition of the RBK mills, St Felicion made up roughly 74% of the capital assets at that time. If MV approximately equals BV, & the mills have been maintained, then St Felicion is worth around 274M +/- as at Sep-30-2011. Were ABH to agree, FBK could pay off its entire debt (103M), buy back every share issued (130M), & still increase cash by 41M. If FBK just bought back 75% of their stock (97.5M), cash would increase by 71.5M, & BV (=MV) would be around 7.77 on 32.5M shares. Lot of ways to slice & dice, but they all result in a higher share price for FBK SD

We're inclined towards >80% chance of a price increase. We also think the transaction will ultimately go through, but probably with some modification along the way. Example: Assume ABH only wants the St Feliceon mill (SPECULATION). (1) ABH could take all of FBK, ring-fence the RBK mills in their own sub, & sell the mills &/or spin off the sub via an IPO. Simplest, but more new ABH share issuance. FBK rises because the exchange rate improves. (2) ABH takes just the RBK mill, but FBK has to buy back the tendered stock at the offer price. Less ABH share issuance, but they need to pay enough cash to ensure that FBK can buy back its stock. FBK rises because the share count drops. The folks around the table are more than capable of arriving at a solution. SD

It is a little more accurate to include our hedges when we say "fully invested". Taking this approach there is a lot to be said for keeping your equity portion fully invested (as your price level view could be wrong), but you will make your money (short term) from adding/lifting your hedges as you see fit. How much you have allocated to equity, versus prior years, is a different issue based on risk tolerance. If you think you can hedge well, you may be willing to tolerate a higher equity weighting. SD

Couple of final comments. Agreed, there was no other practical way to take out the institutions other than via a bid for all of FBK. The bid had to be orchestrated from pretty much only one source, & we should all be thankful to get out at $1.00. Agreed EV was around 130M. That was the offer price & it included the typical >30% take-out premium. The offer was the lowest possible, but fair. If we believe in IFRS accounting, & its associated impairment testing, the BV should be reasonably close to the MV of the assets & liabilities were the business to continue as a going concern. Furthermore, the principle is so well established that ABH will be able to use it - to write-up the value of the net assets acquired to about their former BV. The difference between BV (350.6M) & EV (130M) will result in an accretive 220.6M addition to equity for no new share issuance. Most would argue that how that 220.6M is split between buyer & seller, would be negotiated. The folks around the table are more than capable of coming up with a reasonable saw-off. SD

"Are you thinking the assets may generate more interest if they are split up and sold off in pieces?" 1) We think FBK needs an appraisal on each of their mills. 2) We think the mills need to be shopped to determine buyer interest & the accuracy of the appraisal. 3) We think FBK needs to reconcile & explain why the Sep-30-2011 $369,719 BV of the P&E is only receiving a market value of $112,519 (at best). A $257,200 (70%) difference of $1.98/share. 4) We think FBK needs to review the results of the IFRS Dec-31-2010 long term asset impairment testing & explain why either the bid valuation, or the P&E BV, is not appropriate. 5) Our expectation is that FBK will be able to show that the P&E BV is about what the independent appraisals/bids/DCF valuations come in at. ABH either pays up or walks away. 6) We think there is a >50% chance that a FBK mill will get sold, FBK shares get consolidated, & FBK rebrands into just a RBK recycler. Best guess is that ABH pays up (with equity), then sells the RBK mills (for cash). Materially improves the ABH D/E ratio, takes out the FBK shareholders cleanly, & lets everybody move on. An elegant solution, but we suspect that it may well be Plan B. SD

Doc. We know the stock in lock-up is going the share route; that leaves a remaining 70.5M shares that could take the $1.00/share in cash - yet there is $71.5M of cash allocated. Hence you can be pretty certain that if you want the $1.00 in cash, you are going to get it. What the ABH stock price does in the interim is essentially irrelevant. LessThanIV. Agreed it is unlikely there will be another bidder, but FBK does not have to agree with the price & can put its plants up for sale to extract a better price (which diligence requires them to at least attempt). Also agreed that ABH will likely prevail - but they are going to have to cough up. Even if ABH offers $1.45 - it is only 59M (3.7M shares), all of it will be additional equity, & the Dec-30 working capital sale adjustment (Q4-2011 earnings) will cover some of it. How much is your reputation worth to you ? & do you really want to smear it by being cheap, when you should be gracious ? These things happen, & price is a negotiation, but you still have to put up. No cheap suds! SD

"The deal seems to be valued around 4X a reasonable estimate of EV/2012e EBITDA . That's perhaps a little too cheap but in the vicinity of proper multiples for a single product pulp company. Most seem to garner multiples of 4.5X to 5X EV/EBITDA" 1) Keep in mind the power generation EBITDA of 4-6M/yr starting 01/01/2013. Roughly 5 x 5M discounted at 7% ? (debt rate) for 1 yr; 23.36M/130M shares - or an additional 0.18c MINIMUM. 2) Assume another 35M MINIMUM of market value > book value for all the P&E. Another 0.27c/share. They need to be thinking about getting above at least $1.45. SD

Trading at <$1.00/share. For many - there is simply disgust & little confidence that ABH will improve their offer. They just want out, & are willing to give up a few cents for the liquidity. The price is not rising above $1.00 because there is so much selling. But ... that $1.00 price will still be there over the next month, & everyday that goes by increases the pressure to be more accommodating – especially if a chunk of the 3M+ shares sold today are going to less polite activists. It is not hard to see what FBK paid for its plants, & to come up with an approximate market value in today’s market. That MV is > the carrying value, & at a minimum - that difference needs to get reflected in the price. Stay 30 days & make a certain 5% (1.00/.95) - possibly a lot more. Or sell now for an uncertain > 5% somewhere else. It doesn’t cost anything to stay & bitch loudly. SD

This proposal has to pass due diligence at both boards. FBK needs to prove (1) that its liquidation value (appraisals &/or getting bids on the plants) is above the offer price & (2) that the going concern (IV) value is above the offer price. The current price of $1.00/share is just the offer price the last time they went out. ABH needs to prove that they put up an appropriate initial offer (price & lock-up), & then settled on a number that was independently proved as reasonable. Most would argue that if you want FBK, you need to pay something between the liquidation and IV value. The institutions that bought at $1.01 last time out will want an appropriate return on that additional investment. They will also want the bid to at the very least, materially cover their average cost bases. We would expect that most of the non lock-up group consists of these institutions, & that the lock-up group has essentially withdrawn (via the agreement) to allow them to set the final price. It is highly likely that the bid was intended to raise a fuss, but the degree of distaste was unanticipated. Not a bad thing, but now is the time to demonstrate the elegance that would appear to be behind this bid. It is highly likely that the ABH bid is the match that sets off an industry consolidation wave, raising the tide for all in the industry. To play the bid you really need to buy FBK & anticipate by how much ABH might improve the exchange rate for an all equity deal – then multiply by the probable increase in the ABH share price as a result of the offer. That kind of demand on the small FBK public float, should be an good indication as to where the true floor price might be. May it be an interesting day. SD

Look into the operations of most TSX listed companies. Often a high % of the sales revenue is from outside Canada, & a good chunk of expense may also be in foreign currency (Indian call-centre, foreign assembly centre, etc.). You already have FX exposure - you don’t need to buy it. Often forgotten is that the $C is a petro-currency backed with probably THE largest oil reserves in the world (Tar Sands + Beaufort + Hibernia). Given that most would expect another Bretton-Woods/Plaza Accord following Europes eventual resolution, it is hard to see why the $C would not settle somewhere in the $1.50-$2.00 range. Probably over a few years (BOC intervention). SD

At 90% you can force the minority to sell. Given that this a friendly deal it'll be what the majority of the remaining shareholders want to do, that will decide it. The major players in that group will also negotiate the exchange rate on everyone's behalf. Couple of beers around a table, & saw-off somewhere around half-way between $1.00 & IV. SD

Alert. Keep in mind that it is highly likely that most/all of the shares in lock-up will opt for conversion. Makes the sale a tax-free roll-over, & the holder indifferent as they have not lost any value. Arguably, if enough shareholders opt for conversion (90%+) they could collectively negotiate for a better price (liquidation value) & 100% conversion. The buyer gets a bigger equity issue, & can use all of the sellers cash to pay down debt - improving their D/E ratio. $1.00/share may well just be the opening bid. Here's to hoping that Santa is a little more generous! SD

The price sucks at approx 2.7x projected stable EBITDA (with power) of 48.5M, but at least it will be more liquid (with better prospects) holding ABH over FBK. Think they could afford more, but a friendly bid was pretty much inevitable. Looking forward to holding ABH! SD

Re asymmetric bets: For maybe 80% of PMs ?, a short is one side of a pair trade - done to extract alpha, & executed via options to extract leverage and avoid the possibility of an inopportune loan call. The different dynamics drive the typical response. Most see the asymmetric bet as a small (but certain) realized outflow against a high (but very uncertain) REALIZED inflow. EG. Long a marginally out-of-the-money put option on XYZ Coy. Easy to understand, intuitively obvious, but most don’t get that the magnitude of the payoff x its probability is key (Taleb) ... But an asymmetric bet can ALSO be as a small (& certain) realized inflow against a high (but less uncertain) UNREALIZED inflow. EG. Long a T-Bill & short a put on XYZ coy - or - selling existing XYZ coy & repurchasing later (synthetic short). Not so easy to understand is that the intent is to get called (to the get the stock cheaply) & THEN HOLD IT, & it is not intuitive that Mr Market is going to pay you to do it (premium + T-Bill interest). Examples might be BAC, RIM, etc. We use variations of the synthetic short extensively, & find that in a concentrated portfolio it materially reduces month-to-month volatility. Given that the risk is that the stock could run while you’re short, we don’t sell more than 50% of our position. Hope it works for you. SD

Know what you’re trying to hedge & why. Measure ‘wealth’ by sustainable cash flow. Most retail would systematically withdraw investment funds, reduce debt to low levels, & maintain debt service at current rates. The hedge is against loss (on those funds withdrawn) & caps the major cash outflows (interest rates can now double if you hold only 50% of the previous debt level). Most retail would also invest for positive CF, & sell covered calls - patience, call premium & dividends as a hedge against loss. Pops to periodically take out the position & associated margin. Patience to repurchase on dips at 5-10% lower. Notable, is that this is pretty close to the Taleb approach – but for different reasons. SD

Core to Cdn financials is concentration in few hands, & the omnipresence of OSFI. Risk management is extensively examined every year, & there is little tolerance for chronic repeated failures. The result is better financial resiliency, less volatility, & on-going focus on day-to-day business. When Canada hit the debt-wall in the early 90’s, the Cdn financial sector did very well – most would argue that today, the sector is materially stronger than it was back then. It is much harder to get a double on the retail businesses, as you really need a sustained & extreme external event to materially force down the multiple. The businesses themselves are going to reliably continue generating EPS, with at most a 15-20% reduction off the ‘norm’. The source of that EPS is now also increasingly diversified outside of Canada. The big questions are currency & the benchmark. A double in a hard currency may be equivalent to a 4 bagger in a softer currency, but only if FX depreciation goes your way. The unemployment rate, usually trumps a rising dollar – hence a crap shoot as to where FX might go over the mid-long term. OK place to be, if measured against the TSX; a great place if measured against the DOW, DAX, FTSE, etc. If you want 25% compound returns this probably isn’t it. If you’re OK with 15% & some FX risk, there are lots of choices. SD

The case for the defence: BAC is 1 of 4 unique oligarchs in the US. If someone else wanted to be BAC they would effectively have to buy the company (established relationships, market share, etc). And even if BAC had to massively dilute to weather the coming storm, the buyer has nowhere else to go. The only question is how material an interim direct stake the fed might take – as if it is good enough for AIG, GM, etc. it is certainly good enough for BAC. There is nothing wrong with threatened &/or state intervention. WEB used it with GS. HW has used it with the Bank of Ireland. Today - both GS & the Bank of Ireland are doing very well. Most would argue that for the price paid - both investors have either done very well, or may reasonably expect to. Venture Capitalists have long practiced J curve investing, & currently a long-term investment in BAC is really no different. However - unlike a start-up, BAC has long established relationships, market share, etc. One hell of a moat, that actually strengthens when they start a buyback at some distant future point. It is highly likely that over the long-term, BAC is a solid investment. But until Europe resolves ... there is probably no rush - which is what the absence of insider buying is saying. SD

Keep in mind that a stress test is after the really bad stuff has been repo’d off the books – in today’s market it will the best possible outcome after the MAXIMUM POSSIBLE manipulation. All (Asia as well?) central banks (& agents), insurance companies (with different quarter-ends), & Hedge Funds (non regulated orbit) swapping dung for T-Bills over the cut-off date – to give the banks the maximum possible regulatory capital. Subtract actual from desired capital to find the capital shortfall – for the financial system as a whole – then force the banks to raise it, allocated by market share. Yet all seem to be 100% certain that BAC will not have to dilute (again), when we know that regulators have (publicly, via the leak) warned of insufficient capital ? To most folks a public warning implies that the target is currently BELOW its minimum capital requirement, & that existing anticipated capital raises have already been anticipated (which will bring them back on side). There are lots of ways that big friends can help with the capital, but is it really likely that there will be no further dilution? SD

Some observations: BoA grew assets by 3x (2250/750) over a 6 year period during the credit crunch. Created a hell of a BS strain; but as a good portion of that growth probably has an implied fed guarantee - the risk is not solvency, it is dilution. The global credit mess is likely going to require all banks to hold more capital. That capital can only come from calling in loans, reserve releases from improving loan quality, asset sales, reduced exposure to the higher risk business lines, &/or dilution. Fewer assets, generating less margin, & dilution risk largely dependent on uncontrollable macro factors. Going forward, a lower earnings stream that could well end up spread over more shareholders. It is implied that BoA remains as one entity over the ‘work-out’ period. That may not be reasonable, as most would expect regulatory & business incentives to develop - that spin the businesses into separate recapitalized ‘banking’ pillars. Going forward, multiple (& initially lower) earnings streams, virtually assured dilution, but capital in place to grow what are now healthy Balance Sheets. At 35% dilution (guess), consolidated income needs to increase by 35% over ‘X’ years – just to maintain the current EPS. To make money during the period - either the P/E ratio must increase, or earnings must grow faster than dilution - & all with a high probability of it actually occurring. The longer ‘X’ is, &/or the lower the probability of it actually occurring, the lower the expected compound return will be. To offset the risk you need a very low cost base, but post ‘X’ this is a growth stock with the commensurate return. There is a need to recognize the reliance on ergodicity (the longer the event path the more the eventual possible outcomes resemble each other). Just as a bad trade will catch up with you the longer you play, the same applies to the good trade. As long as BoA does not bankrupt - the longer the ‘X’ year period is, the greater the certainty in a return to ‘normal’. Punch-card bet, but you have to be prepared to marry it for what could be a very long time. SD

[amazonsearch]Fooled By Randomness[/amazonsearch] Very good ‘heretic’ read for those statistically & market minded. To get the most out of it, expect to re-read each chapter & map out what you are being told - as it is not intuitive. Then expect it to completely changes your view of markets. Snippets from Chapter 2: You will probably not do very well if you ... - Don’t recognize that history is written by the winners, not the losers. If you’re a despot but invade someone & win, you’re a hero. You’re still a despot - but no one will hold it against you! - Don’t recognize that the idiot who can present well - comes off as the expert. The alchemy of the CNN talking head! - Don’t recognize the Risk Management is done to give the impression of Risk Management – not actually do it. - Don’t recognize that you should insure against the abstract risk, not the vivid one. The vivid risk is already priced in - the abstract is not, & the reason why HW can occasionally make 2B on CDS swaps! SD

Agreed re Greenblatt. But assuming no real change in share price until IV is realized - there’s not much difference. Nice thing with the equity though is that the timeframe is open-ended, & buybacks (speculation) tend to increase both floor price & liquidity. You may get an opportunity loss, but you’re unlikely to lose on the actual investment itself. Obviously, not for everyone. SD