Wednesday, February 19, 2014

Something for Nothing ??

For a skeptic, I am generous in granting "the possible" underlying an investment thesis in pursuit of something like a boundary to its worth, however incredulous it, or its assumptions, may be. One can subsequently quibble over the details be it the forecasts, rates of discount, exogenous risk factors and so forth. As a skeptic, I am often at odds with the optimist, or a central case that involves the alignment of astral bodies, but it is rare that I just don't get the thesis, however flawed it's assumptions may be or prove to be, or however misplaced my Scottish sense-of-doubt.

AAMC is one of those rare instances where I continue to rub my eyes in disbelief at the market value attributed to income streams yet to materialize, however magical the annointed touch (and ownership) of Mr Erbey, or lucrative fruits of contractual obligations that will eventually flow to this obscure, though highly-prized vehicle, whose market cap peaked at more than $2,500,000,000, and currently resides still-north of the two-large-unit mark. My feelings oscillate between derision, awe, and wonderment. The awe derives from the reality that its value, as attributed by "the market", has increased twenty-fold in not much longer than it takes to bake a cake, emphasizing that it this not a twenty-fold increase in a penny stock. It is $2.2 billion of market cap approx 30% of which Mr Erbey, if he so chooses, can monetize into real currency to buy real things like a Yellowstone Club chalet, Gulf. IV or London Chelsky-Prospekt town home. And, for all we know, through structured transactions he may have already constructively done so. The wonderment derives from my ignorance into what future course of events will provide this fee-splitting recipient entity with the demonstrably large cash flows required to justify its ambitious market value (a wonderment which is less a skeptic's DOUBT as to their eventual arrival than a cry for some numerical quantification and justification). Network effects, scalability, rapid adoption and a global market are concepts I find easy to understand, and visualize in a spreadsheet with figures that rapidly add zeros to the end of increasingly-large numbers over time, and while I freely admit that I am not well-wired to invest effectively in this way on the long-side, such tangible forecasts of growth scare the bejesus of out of me on the short-side. This wonderment then leads to a plea: will someone please share their spreadsheet of the same for AAMC - the one that spawns additional zeros in future years like cancerous cell division - to satisfy my curiousity.

Apparently, some have such a spreadsheet or merely great confidence (or both) - in the thesis that will provide the cash-flow and the certitude of their arrival, evidenced by the large positions this unusual entity occupies in their portfolios. Long Pond Capital LP, Luxor Capital, Sab Capital Group, Tiger-Eye Capital, White-Elm Capital have (and it is not understatement) massive positions in this (with massive defined as a huge slug of said Hedge Fund investor's capital by any sensible risk-manager's measure). This is rounded out by FMR, Cap Research and Neuberger all with sizable positions, though not in relation to their behemoth size. Now, you would not be wrong if you detected a tad of derision (complementing the awe and wonderment), for all the arboreal southern-Connecticut-sounding buyers (except Long-Pond) appear to have hitched their investors' monetary wagons in Q3, no doubt the primary accelerating force in taking the shares from $250 at the end of Q2 to $500 at end of Q3. Together, (with the big-3), they represent approximately 50% of shares-out (80% with Erbey's apparent 30%), causing marginal purchases to have an amplified impact on the market price, and anyone who's been short, rather blue-in-the-ass. Though there is no evidence of collusion or a cartel, (however tempting this would be amongst friends) collectively, purchasers have, in Q3 and Q4 created "a lot of something-out-of-nothing".

Some will argue that mark-to-market is of less importance.  They will discount ebbs and flows in market value fully understanding that they are, rather often, ephemeral.  That may be true for a principal  investor with said shares in their portfolio, but it is not most NOT for a hedge fund manager purchasing, holding, and/or purchasing more of said shares, . The Hedge Fund Manager, it should be highlighted, for the avoidance of doubt, realizes their profitable interest at the end of the performance period, (rather often Dec 31st.) crystallizing their profit share - independent of whether market-to-market profits are ultimately realized. They do, for the sake of fairness, concede to the investor a "high-water mark", before which they will not extract further performance, but this is a small bone of uncertainty with little tangible value, juxtaposed against the certainty of receiving what are to most observers, unimaginably-large sums of money.  What remains for the investor, again for the avoidance of doubt, is still something ephemeral - minus 20% of the "profit" after costs. So looms that little chestnut known as "principal-agency conflicts".

Some (me included) will wonder why AAMC increased 40-fold from its opening print. Have it's prospects dramatically improved or was its initial post-spin-off price meaningfully undervalued (or perhaps both)? From cursory inspection, there appears to be no shortage of Machiavellian shell games within the Ocwen ecosystem that involve carving-up income streams and optimizing ownership amongst vehicles and and their domiciles.  The benefits to non-executive shareholders may be uncertain, but the potential advantages for optimally-structured executive owners to advantage from aggressive structuring shouldn't be lost. Housing recovery convictions have also firmed. Some prescient investors flagged AAMC early, touting it's target value incredulously at multiples above the post spinoff price - upwards of $250 to $300 a share - which it quickly achieved via a dramatic triple in Q2 of '13. Allowing for a large error term in their forecasts, one might grant $500/shr (a $1bn market cap equivalent) - the heights it climbed by the end of Sept 2013, and which was the basis of quarterly filings of the last known positions. Yet with further little change in the housing market, or the firm's idiosyncratic prospects during Q4, AAMC's shares went positively priapic straight into the end of the year performance hedge fund finish line, taking the shares to more than $1000, and the market value of AAMC well north of $2bn. This may be coincidence, happenstance, or serendipity. Only the DTC may know.

Of course, it is possible that, $2bn is the correct value for AAMC, and that Mr Erbey gifted a massive increase market value to potential purchasers when AAMC was spun out. This may even be likely, for the tax consequences of transferring interests to more advantageous structures at low value are far more advantageous than doing the same the same at high value. If so, nice work if you can get it. However, I cannot purge from my skeptical mind that there is something more to the story than a bull-case for growing earnings in an Ocwen affiliate; more than short squeezes and hard-to-borrow securities. I remain curious, and think investors in funds with large positions would be prudent, themselves to understand what motivated their agents to accumulate large concentrated positions in an illiquid stock, and/or perhaps more importantly, to hold and even increase said positions to what to the uninformed is the point where hope might legitimately begin to exceed potential. And, if you find out and wish to share it, I will happily share it here.  

1 comment:

Charlton Butler said...

I'd say off hand, and subject to correction of course, that you have not investigated the MBS market fully and understood what happened there then it would occur to you, I'm sure, that with the falsity in the origination of alleged loans allegedly bought by REMIC trusts, that it is now a demonstrable fact, were in fact never created, could never have bought any loans, and as they were unfunded trusts that makes them, legally and factually, nothing. This would I assume make you think about the fact that this is a good place to hide all that dough Banks siphoned off from investors, municipalities, pension plans and homeowners.