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December CFA Valuation Conference


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Is anyone else going to this conference?  It is in NYC on Dec 3-4 and is going to have Marty Fridson (WEST board member & HY analyst) and the int'l manager from 3rd Ave speaking amongst others.  The cost is higher then other conferences but last year in Toronto the conference was great.  If anyone is going or is in NYC on those dates, let me know and we can meet up for dinner one of the two nights. 

 

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Packer - did not see this until now. Sorry.

 

We should compare notes though.  I liked Tilson, a lot. 

 

Also like Haugen (surprising, I had never heard of this guy before).  I looked up his paper, haven't read it yet though.  For everyone else's benefit, this has published a paper claiming to defeat EMH with a factor model.  His factors have negative risk/reward relationships.  Higher vol stocks have lower predicted returns; cheaper stocks have better returns, more liquid stocks have better expected returns.  He has about 50+ other factors too, negating risk-return relationships that would be expected.

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Tilson was informative.  If you would like more detail you can read his book.  I bought it about 6 months ago for one of our client engagements of valuing defaulted whole loan portfolios.  Other highlights include:

 

Strategas Outlook: Some Japan analogy info (Japan savings rate (14%) US up to (4.5%), alot of rallies as a part of larger decline (7 rallies of 60% over 20 years)), believes China is just a large jobs program and high commodity prices are due to China's purchases and this will continue until inflation outweighs employment gains,  China is increasingly funding only short-term treasuries leading to potential liquidity crises when the paper needs to be renewed, velocity of money indicator positive for stocks and alot of money in money market funds (34% of US market capitalization).  I have heard this guy at our local CFA group and he was quite good in providing macro outlook and provide some interesting themes for investing (defense and lobbying stock for example)

 

Damodaran:  His typical valuation talk that he gives here and at other venues like the ASA conference.  Key points: when doing foreign currency valuations pick a currency and stick with it for all your assumptions in valuation, equity risk premium (historically 2* Baa spread and had an interesting paper about on web site, described his bottoms up industry beta approach (which I think makes alot of sense), described illiquidity as a spectrum from bid-ask spread on traded stocks to studies for private firms and illiquidity may change over time as the markets in general are more illiquid, when valuing firms dependent upon market forces develop a range of values/scenarios - for example oil firms (a range based upon changes in oil prices) and banks (a range based upon changes in RoE and cost of capital), when performing valuations that are effected by discrete/binary risk (expropriation, high probability of failure - start up) handle those as scenario by applying probabilities versus including in discount rate,  one way to handle truncation risk (a discrete risk)is to estimate probability of default from bond prices and apply on a weighted average basis to stock prices and suggested adjusting debt values for firms who have debt less than BBB. 

 

Maverick Capital: Real US interest rates are already @ 5% to 6% (primarily due to deflation), high-yield spreads have come down but are still high by historical standards (800 bp), high money market levels indicates little retail participation in market, the Fed has to extract about $1T in liquidity from the system, free cash flow as a % of GDP at record highs due to capital discipline and lower S,G & A costs, more wealthy consumers have been hit more by asset bubble pop than less wealthy ones (not the usual pattern) and may spell trouble for retailers as this group spends more than other groups, filter for picking stock - look for where the prices are going up versus down.

 

Haugen: Multiple return factors for stock - similar to concepts described in his book and others have developed similar factor models like R. Roll of UCLA in the past.

 

Accounting Update: Convergence of US GAAP to IFRS

 

Tilson's presentation: presentation of projected resets and defaults for Alt-A and Jumbo markets, stated we are 50% to 60% through bank bubble-write offs and normalization of write-off levels will not occur until 5 years hence, the issue with write-offs is timing (alot at once causes liquidity crunch versus long-term write-offs allows bank profits to cover losses), stated drop housing inventories was artificial as about 14 months of inventory is stalled in foreclosure process (foreclosure sales have declined by 50%),  FHA is a disaster waiting to happen as 2-3 year default rate is 30%+ due to lax controls and risky lending, looks for a 10% further decline in housing prices as above factors and affordability will sloe decline, consumer credit is falling as banks and consumers are re-trenching, commercial RE is a smaller % of large banks portfolios and will hit smaller banks harder, estimated losses of $3.5T will be spread over 7 years due to extensions and these extensions are dependent upon low interest rates (if interest rates spike many of the loans will default as debtors can pay interest at lower rates but not at higher rates), consumer debt has peaked in @138% of disposable income and has now declined to 129% (historically it has been below 100%) this increase has benefited financial services firms which will now face head winds.

 

Public/Private Firm Valuation - primary methods used multiples and to a lesser extent DCF, talked about how brokering process gets management's emotions involved and bids up prices of firms with a focus on how much you can afford versus reasonable purchase price, Credit availability for deals has declined from 1x 1st year EBITDA-Capex/Interest to 2x, LBO deal multiples have declined from 9.7x EBITDA to 6.4x EBITDA, felt control premium based upon enthusiasm of buyers and access to cheap financing, described development of DCF from RoE on BV based model for financials,  for many large banks money management and processing businesses are providing profits to cover balance sheet losses, high yield market now opened due to high free cash flows banks are now in the market and about 50% of the loan market disappeared with the demise of the CLO market.

 

New Normal for financials – described speculative bubble process in financing as going from hedge financing (paying off interest and principal), to speculative financing (paying interest but not lowering principal) to Ponzi financing (not paying off either interest or principal but being dependent upon price appreciation to pay back loans) and how securitization facilitated this process, described evolution of financials from discrete home loans, commercial RE loan and consumer credit segments in 1970’s to an integrated model driven by securitization,  historically there were buffers between these markets to prevent contagion shock, securitization history can be broken into three periods (1st – the time tranching of mortgages in the 1980s, 2nd -  the regulatory securitization of the 1990s (REMIC legislation allowed banks to place securitizations off balance sheets – this is now being reversed) and 3rd – diversification arbitrage (non-correlated asset classes can lead to lower risks – this has been shown to be false as during stress these assets classes become highly correlated due to in-part removing of customer and client barriers (the clients and customers became the same entities) between the asset classes from securitization),  this recession different from recent past in that it was driven by credit bubble bust versus inventory recession,  recent similar type of recession can be seen in Japan,  high RoEs from banks (1990s to 2000s) was driven by increasing loan demand (7.2% since 1990 vs. 0.2% in Japan), in Japan (according to Koo), with bubble burst banks moved away from profit maximization and to debt minimization and with the private sector delivering new reserves cannot leave the system due to low loan demand the result is the economy will not enter growth phase until the private sector balance sheets are repaired, in Japan, this process led to a $45 trillion loss of wealth, Japanese banks had too much capital in 1990 and the resulting RoEs over the next 20 years was a negative 18%, US banks have too much capital today and combined with low loan demand may become more like utilities with utility-type RoEs as seen in the 1950s-1970s of 7 to 9%, in addition ,the upside of for financials has been removed via higher capital requirements and more government intervention in the markets. 

 

Fridson HY analysis – HY analysts more concerned about downside and financing catalysts than equity analysts, looks at returns (spreads) from different layers of capital structure to find mispricings, a high-yield bond recommendation (based upon FCF analysis) he gave was extended to a stock recommendation which lead to a favorable outcome for both with the stock going up more than the bonds, does not use options-based models for HY pricing due to lack of HY pricing availability but does use them to value bond features (calls, convertibility and covenants), current market 20% bonds are trading at distressed level (HY spread 1000bp) and there are prospects there, market (740 bp) still below average spread of 550bp, rating agencies have done a better job in corporate ratings due to debt deals not being dependent upon what the rating results are in contrast with the ABS market.                 

 

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Tilson was informative.  If you would like more detail you can read his book.  I bought it about 6 months ago for one of our client engagements of valuing defaulted whole loan portfolios. 

 

What type of work do you do?  A lot of the work the group I'm in does sounds similar, providing third-party valuations on illiquid securities.

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I am a partner in a valuation firm (Empire Valuation Consultants).  We value private enterprises, securities and intangible assets for transactions, lending, financial reporting and tax purposes.  I focus on the derivatives, intangible assets and the technology portion of the business.  What is your role and firms name?

 

 

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I'm with Houlihan Smith in Chicago.  I'm in a valuation group that does performs similar services to what you described.  The group performs a broad range of valuation services, but the valuation work I focus on is typically structured products.  From time to time I'll do corporate valuation work as well (typically for transaction purposes, fairness opinions). 

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