txlaw

This was a great piece. Really crystallizes what I think is "intelligent investing" in the O&G space (which includes points to consider by both Professor Bakshi and Friend). I pretty much agree with every point except for parts of the last three by Professor Bakshi and point two of Friend: ------ Friend, Point 2 -- The Friend assumes that the cost of production will remain flat as a result of using up "best inventory." I personally don't think this is the case, and one ought to prepare for the cost of marginal barrel or MCF to go down for unconventional producers. That appears to be a defining aspect of the unconventional revolution in the US. These guys continue to be able to reduce the cost to produce these barrels/MCFs. The consequence of the notion I've articulated above is that the "equilibrium" price point around which oil/gas will trade -- i.e., the price where the marginal barrel meets demand -- could continue to go down. In such a market, the rich producers (those with lowest costs) will be alright but their margins will compress, and producers with full-cycle break evens closer to the marginal barrel price have to be in an "arms race" of sorts to get an acceptable full-cycle ROI. ----------- Bakshi, Point 6 -- As yadayada has pointed out, people often confuse the difference between cash break even and full-cycle break even. And it is primarily the discrepancy between cash break even and full-cycle break even that keeps people producing in a "noneconomic" matter. For example, oil sand producers can make cash margins on oil production at very low oil prices because their capital investment has been front-loaded. And it is entirely rational for them to produce oil from those assets and make those cash margins in order to pay down debt and potentially invest where there actually is a full-cycle economic return, even when the full-cycle ROI on previous investments appears to be very poor (or even negative). Thus, in pure commodity businesses that are very capital intensive, we often see prices trading below the "equilibrium price" for a long time. Note that just because the above phenomenon occurs does NOT mean that a secondary market investor cannot make a return in this type of situation. Because ultimately the secondary market investor gets to choose what price he is paying for the assets and liabilities, which has nothing to do with the amount of productive capital that was put into building the assets. Another way of saying this is that when one looks at the "replacement capital" cost for a collection of assets, one often comes to the conclusion that the capital that was utilized will never generate a present value of cash to justify the amount that was spent. This is why I personally think "replacement cost" is a poor method for valuation. But the flipside to this is that the secondary market investor doesn't have to pay the replacement cost for an asset. He can pay cents on the dollar and get a very nice return based on the price paid. In the context of an oil sands producer, for example, it may turn out that the amount of capital put into these projects was wasted from a financial perspective. But if the assets can churn out cash margins at $30 a barrel for the foreseeable future, there is obviously a price the intelligent investor will pay for the assets to generate great returns going forward. --------- Bakshi, Point 7 -- A pithy WEB saying is always fun to use. But the counterpoint is that being a lowest cost commodity producer as a result of technological innovation and asset selection/purchase, plus proper financing (not being over-leveraged), is essentially the way to be smarter (though perhaps not a lot smarter) than your dumbest competitor. And being smarter is the right way to generate financial returns in a commodity business. Although luck obviously can play a huge part as well. It’s worth noting, btw, that WEB is invested in several commodity businesses where the businesses are said to be a lowest-cost provider. POSCO is probably the example that is most analogous to O&G. While Munger does argue that POSCO is almost a tech biz, the fact of the matter is that their commodity-like businesses dominate, and being a low cost, high quality producer is where the tech savviness plays a part in the moat. -------- Bakshi, Point 8 — It’s unclear what Bakshi means by having enormous staying power. Is he referring to producers or is he referring to investment managers? Given that he is talking about no debt at all, he appears to be talking about investment managers rather than producers, which means he is conflating the issue of whether O&G businesses themselves can make intelligent investments with whether investment managers should stay away from O&G. Also, Bakshi’s bias towards “branded” as opposed to “commodity" businesses makes sense as a general rule re: when determining whether or not a business is a “great” business. However, one always has to keep in mind the price paid for a business. It is folly to believe that there will necessarily be pain in "seeing other people who invest in businesses that buy commodities but sell branded products get rich in environments when commodity prices are high or low.” Because many of these other people will be overestimating the moats of these “branded” businesses and paying rosy (and perhaps outrageous) prices for these businesses. In other words, if you are buying commodities producers at outrageously low prices, it’s not a given that those buying “branded” producers at outrageously high prices will have the leg up. ----- Anyways, just some thoughts I wanted to put to paper after reading a very thought-provoking post.

Very nice, Gio. How did your investment portfolio do? 20% Liberty... Not as good as you, but not bad either... As you know I hold a large percentage in cash! Cheers, Gio Nice job, Gio. Although I disagree with you on a lot of your posts/views re: intelligent investing and macro matters, I contend that your rock solid approach to investing will likely have you returning well above the average investor for a long time. And 20% is a great return, btw. The average person would kill for such a return.

Approximately 12%. O&G has been a pretty big drag on the portfolio this year, what with the premature accumulation and all.

Fantastic post. The only thing I might add is that "value investors" tend to also have a favorable bias towards businesses succeeding and generating economic/financial value. The glaring exception seems to be with companies engaged in fraudulent activities, and it's no accident that the most admired short sell trades -- and they are trades -- are the ones that have ferreted out such fraud. One thing's for sure, though: it's tough to do really well short selling. The best way to do so is to convince other people that you are so smart and skilled that you are one of the few investment managers that can really add value by shorting/hedging, and to market your product as a part of a balanced investment strategy (similar to Chanos spiel).

So they've been dead wrong for the last 6 years, but the market declines over a week & 1/2 period, and now they're right? This thread is ridiculous. Yeah, I agree, although I would tend to be a bit more . . . shall we say, tactful? Actually, I love to see this sort of sentiment get expressed by value investors because that's how you really know that people are fearful. Twitter is also great (or, maybe, horrible?) for gauging market sentiment amongst value investors.

Daphne is referring to the hedges, presumably. Of course, the S&P 500 is still up almost 60% in the last 3 years so . . .

Congrats!

I don't really get the Passport, but I think it's possible that they sell a decent amount of devices. To me, the key metric of the device's success will not be that it sells in huge amounts, but that the amount of devices manufactured by Foxconn is somewhere close to what the demand is for such devices. In other words, these new device launches are most instructive for determining how the inventory management partnership is working. Even though the biz media is characterizing the Passport's release as BBRY's key attempt to get back to relevance, it's really still a small piece of the puzzle. The biz plan clearly is still to focus on software and services, with key assets being deployed for MDM, security services, and M2M/IoT. The Passport itself will probably be marketed heavily to certain verticals. They're really trying to push the image of how the device is great for working in spreadsheets and viewing medical documents (like X-rays). This indicates that they designed it for the finance and healthcare verticals. If they sell devices successfully into those verticals, they are likely also successfully selling their software and service offerings to those verticals because most people in NA only use Blackberry phones when an end to end BBRY solution has been put into place by IT.

So, does anybody want to give an update on FFH's China-related hedges? Have they been benefiting from the downturn in commodities?

Capital find, old chap!

You have to be careful not to confuse shale oil with oil shale...there is a difference. If I recall correctly shale oil is oil trapped in shale rock similar to nat gas, and can be fracked just like nat gas. Oil shale is in the rock and can be mined similar to coal. Shell had a big deposit in Colorado it spent something like 40 years trying to figure out....... http://www.shell.us/aboutshell/projects-locations/mahogany.html cheers Zorro Wikipedia, my friends, Wikipedia . . . https://en.wikipedia.org/wiki/Shale_oil https://en.wikipedia.org/wiki/Tight_oil ;)

Fantastic. Thanks!

http://www.economist.com/blogs/democracyinamerica/2014/08/barack-obama-talks-economist One of the longer interviews I think I've ever read with Obama.

Yeah, I just read an Andrew Ross Sorkin article about how GS, JPM, et al are making some nice fees from this trend.

Apparently, Windstream has obtained a private letter ruling from the IRS potentially allowing them to spin off their network assets (and associated RE assets) into a REIT: http://files.shareholder.com/downloads/ABEA-43PVYW/3363897455x0x771662/dcf1ce80-c65b-4d8e-962f-3b13a6ac15fa/Press%20Release_072914.pdf http://files.shareholder.com/downloads/ABEA-43PVYW/3363897455x0x771664/75c74b53-ccf1-4196-af0d-faaccf6f4d63/Investor%20Presentation_072914.pdf http://www.bloomberg.com/news/2014-07-29/windstream-to-spin-off-telecom-assets-into-publicly-traded-reit.html And they're planning on going forward with this highly unexpected plan. This private letter ruling seems to be a huge gift to the activist hedgies, who have been pushing for these types of spin-offs. For example, I read somewhere the other day that one of the activists wants paper companies to start spinning off their assets into MLPs. Any ideas of potential targets in telecom as well as in other industries for REITs/MLPs?

There are insights there on the auto industry (think, self driving cars) and a change in work habits (a la Keynes), among other things. The whole thing is definitely worth watching.

Unfortunately, sometimes we also adhere to criticisms of a theory primarily because they fit with our own beliefs (e.g., my particular company or investment is not subject to forces described by X theory). Even when the criticisms are very poorly constructed. As I told another investor, much of the animus in Lepore's piece is directed towards those who throw around the word "disruption" as a buzzword that fits their particular narrative. Christensen, himself, in his response to Lepore notes that he was happy at first to see her criticize the "almost random" overuse of the term "disruption." But then Lepore veers off into criticism that is very shallowly put together and that, frankly, indicates that Lepore hasn't read any of Christensen's subsequent academic work (including the Innovator's Solution), which modifies, expands, and negates some of his earlier work. It's a surprisingly poor piece for an academic to put forth. Any decent academic understands that ostensibly predictive theories evolve over time, although perhaps historians have a different way of doing things because they focus on what happened in the past and try to come up with their definitive thesis or narrative of what actually happened. Lepore equates "innovation" with the idea of "progress stripped of the aspirations of the Enlightenment," but even if that is true, it has very little to do with the specific business mechanisms posited in Christensen's academic work. Then she equates disruptive technologies with business success by particular companies, which simply doesn't follow from the entirety of Christensen's work. It's really more of an industry-wide examination, though it is true that Christensen often touts particular companies as successful innovators. Lepore also criticizes Christensen for declaring that his theory is meant to be "predictive" in nature but goes way overboard in trying to tear it down with the particular case studies he uses. In fact, Christensen's posited "solutions" to disruptive innovation (again, developed in his subsequent work) contemplate that there will be failure by companies who are trying to win the market through their innovations. Having said the above, there are a number of valid criticisms of the Innovator's Dilemma that ought to be put forth (but which Lepore does not). For one thing, Christensen doesn't seem to understand valuation -- he essentially focuses on growth as the driver of increased value over time (buying into EMH in many respects). Another one is that Christensen doesn't realize that the creation of wealth and having one's business subject to "disruptive innovation" is not mutually exclusive. That is, a company can have their incumbent business severely affected by a disruptive innovation, but still generate far more value from the incumbent biz than if they try to "cannibalize" that incumbent biz. These are just two of the criticisms that one can levy against Christensen. Basically, there are always issues if one adheres to a particular theory or mental model as an iron law, particularly if you don't really understand it properly. Indeed, that is the whole point of the "man with a hammer" aphorism. But to agree with a poorly done criticism of a mental model because of "confirmation bias" is also wrong-headed. Here are a number of response pieces worth reading: http://www.businessweek.com/articles/2014-06-20/clayton-christensen-responds-to-new-yorker-takedown-of-disruptive-innovation#p1 http://www.slate.com/articles/technology/technology/2014/06/clayton_christensen_and_disruptive_innovation_is_the_concept_a_myth.single.html http://www.vox.com/2014/6/17/5817824/disruption-is-a-dumb-buzzword-its-also-an-important-concept http://www.digitopoly.org/2014/06/16/the-easy-target-that-is-the-theory-of-disruptive-innovation/ Even the Stratechery guy, who is a favorite of investors in a particular tech company discussed on CoBF, recognizes the faults in Lepore's article: http://stratechery.com/2014/critiquing-disruption-theory/

In case anybody is interested, Walt Mossberg and Kara Swishers' Re/Code venture (the successor to the WSJ's AllThingsD) has finally put up full interviews from the <code> conference. Worth watching if you're interested in the tech world. http://recode.net/video/

I think you're wrong about the price being high with or without Google. Like I said before, Uber is a strategic asset that would be worth a lot more in the hands of one of the tech giants, particularly someone focusing on mapping and logistics. You really think Bonderman wasn't like, oh, well if Google really wants to keep this strategic asset out of the hands of, say, a MSFT or AAPL, we're gonna raise money at a much higher valuation? I would not at all be surprised if Uber does, in fact, sell itself.

I certainly wouldn't want to put money into Uber at a $17 B valuation. But it's possible that there is some M&A strategy going on behind the scenes. My understanding is that Google Ventures put 85% of their AUM into Uber for a valuation of $3.5 billion. Google Ventures apparently put more money into this current round of financing. From my perspective, the data that Uber is generating is very strategic for anyone who is interested in mapping and logistics. One way for GOOG to make sure that Uber isn't acquired by a competitor like AAPL or MSFT would be to jack up the valuation to exorbitant levels. It's also possible that the non-GV investors/owners are basically positioning themselves for a potential Google take-out of Uber, in which case they will demand a crazy high price from cash rich Google to keep it out of the hands of, say, a MSFT. That's one potential explanation for the sky high valuation. In any case, none of us individual investors would ever want to put money into that kind of company at such a valuation.

http://www.bloomberg.com/news/2014-06-05/draghi-unveils-historic-measures-on-deflation-threat.html Amazing.

Check out the Dragon V2 unveil. It's pretty damn cool. http://www.spacex.com/webcast/

Not a ringing endorsement some in this board would say (not me as you know). I actually think Mary Barra is behind the ball. She better start doing a better job. She reminds me a lot of Moynihan exactly because of the PR issues. Ultimately, though, it's about having someone who can chip away at the bad culture and just get the battleship on the right track, which is exactly what Moynihan has been doing (balance sheet mistakes notwithstanding). Neither Moynihan nor Barra are superstars, but they're both "company men" who have the right idea of what the company should become. It is weird -- it's like Marchionne: Barra as Dimon: Moynihan. Hmm, two articles in Forbes this week about Moynihan and Barra: http://www.forbes.com/sites/halahtouryalai/2014/05/28/revealed-brian-moynihans-grand-plan-for-bank-of-america/print/ http://www.forbes.com/sites/joannmuller/2014/05/28/exclusive-inside-mary-barras-urgent-mission-to-fix-gm/

Because I have to load up on them before anybody knows about them. I'm just joking.

I have a couple of ideas -- but why would I tell you guys about them? ;D