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Platform Value: The Fall?

Summary

Discussion of the potential effects on equity, bond, commodity, capital and asset markets regarding:

Pershing Square Holdings, Platform Specialty Products, Canadian Pacific.

Valeant Pharmaceuticals, Platform Value, Leverage.

Index Fund Bubble, Liquidity Gap.

In Los Angeles, circa 1915, a silent movie "flickers" stunt man (Lee Pace) has his legs paralyzed while performing a reckless stunt. While hospitalized, the injured stuntman begins to tell a fellow patient, a little girl (Catinca Untaru) with a broken arm, a fantastic story of five mythical heroes. Roy's tale is about six heroes: a silent Indian warrior, a muscular ex-slave named Otta Benga, an Italian explosives expert called Luigi, Charles Darwin with a pet monkey called Wallace, and a masked swashbuckling bandit.

An evil ruler named Governor Odious has committed an offense against each of them, who all seek revenge. The group is later joined by a sixth hero, a mystic. Thanks to Roy's fractured state of mind (verbal input) and Alexandria's vivid imagination (visual output), as the line between fiction and reality blurs, together they build a preposterous world. A visually stunning epic fantasy (amazingly with no CGI) that the child in you will either hate or fall in love with.

A mad folly, an extravagant visual orgy, a free-fall from reality into uncharted realms. Surely, it is one of the wildest indulgences a director has ever granted himself. Filmed over four years in 28 countries and a movie that you might want to see for no other reason than because it exists. There will never be another like it. - Roger Ebert

Free falling mad folly?

From Bill Ackman's letter to Pershing Square Holdings' (OTCPK:PSHZF) shareholders: "Our biggest valuation error was assigning too much value to the so-called "platform value" in certain of our holdings. We believe that "platform value" is real, but, as we have been painfully reminded it is a much more ephemeral form of value... [which] depends on access to low-cost capital... and the pricing environment for transactions."

We pull no punches, what Ackman really believes but can't say is, his business model is based on keeping people in the market. Much like Roy (in The Fall) Ackman does not "Ack-knowledge" the market folly of the "platform value" paradigm which has obviously caused Pershing Square and his "Valeant Fall."

Platform Specialty Products

Above note, Platform (NYSE:PAH) jumped from $12 to a peak of $28 then collapsed to $5. Did someone play the greater fool with a speculative $5 stock, which jumped to $28, when they paid $25 a share?

Ackman: "Our most glaring, albeit small, unforced error was buying additional stock in Platform Specialty Products at $25 per share to assist the company in financing an acquisition. We paid too much... and because we assigned too much platform value to the company. Our assessment was incorrect."

Canadian Pacific (NYSE:CP)

Above note, Canadian Pacific going parabolic from $25 to $220 then pulling back to $145.

Ackman: "We made a similar error in not trimming our Canadian Pacific position when it reached ~C$240 per share. While we still believed CP was trading at a discount to intrinsic value at that price... it would have been prudent to sell a portion of our investment."

While we still believed CP was trading at a discount to intrinsic value at that tenfold price? Once is a shame on you, twice is shame on me, but thrice is a pattern of behavior...

Valeant Pharmaceuticals (NYSE:VRX)

Ackman on Valeant's intrinsic value: "we would never have expected that the cumulative effect of these events would have caused a nearly 70% decline in the stock, nor do we believe that they will permanently impair Valeant's intrinsic value."

Above note, monthly chart of Valeant Pharmaceuticals 10/08 - $6.65, 08/15 $263.81, 04/16 - $25.27.

Observing a historical monthly chart, in 1994, VRX was a $0.50 stock. During the dot com run up, it spiked to $57.18 in January 2001, retracing to $6.65 by October 2008, by 2013 spiking back to the $60 level, then in short exponential fashion to $250.

Ackman on discounts; "it is rare for companies to trade at material discounts to intrinsic value for extended periods."

What part of this speculative overvalued penny stock's inflation, deflation and reflation is missed in viewing the chart? Does one need a team of analysts to consider the seven-year decline to $6.65 as an extended period? Yet, Pershing bought at an average price of $195? A high dive platform value indeed.

Platform Value?

Above note, as of October 15, 2015, of the $59.3B equity value, 81.5% being $48.4B in "platform value" from which to take a fall or swan dive. Why would any sane creditor or stockholder want to be long this risk? Graphic courtesy of Chicago-based hedge fund manager James Litinsky of JHL Capital.

Ackman on the Pershing portfolio: Contemporaneous with the decline of Valeant, the rest of our portfolio went into free fall, which has continued up until the present.

Above note, weekly chart of Pershing Square Holdings' stock valuation 08/03/15 $29.45 - 03/21/16 -$12.78 - a 57% decline. It would seem that the "platform value" paradigm has had quite an effect on Pershing's portfolio and market valuation. Ackman can only hope said effect is as he put it: "much more ephemeral."

What's Leverage?

Ackman on leverage: "stocks can trade at any price in the short term. This is an important reminder as to why we generally do not use margin leverage...The companies in our portfolio that have suffered the largest peak-to-trough declines are Valeant, Platform, Nomad, and Fannie and Freddie. The inherent relative risk of their underlying businesses and their more leveraged capital structures partially explain their greater declines in market value.... In retrospect, in light of Valeant's leverage... we should have made a smaller initial investment in the company."

This isn't rocket science, but did the experts at Pershing forget the part where investing in a company with leveraged debt (capital structure), even without a leveraged margin position, is nonetheless investing in a leveraged position? As we Nattered in "Eminence Front?", it would seem that everybody has been snorting the "white powder" of financial engineering for quite a while, and all but forgotten the fundamentals.

The Index Fund Bubble?

With declining sales, revenue and profits, which do not match up with future P/E or EPS projections, why do the indices seemingly keep going up and up? Vanguard, BlackRock, and State Street are the biggest managers of index funds, which cumulatively own 12% to 20%, of almost every index component. Accordingly, last year, index funds were allocated nearly 20% of every equity's dollar invested. A reminder, as more capital flows to index funds, the valuation of the index components and the indices increase. There are several problems with this ownership and allocation scenario.

Much like professional financial advisors, index fund managers get paid not upon performance but based upon AUM (assets under management). Despite holding enough proxies (20% outstanding) to control most companies, these fund managers are obviously reticent to rock the boardroom vote or boat. The maintenance of the "status quo" translates into the level of long-term corporate business performance or "competition" as stagnant or compromised.

The "performance based" compensation and boardroom "status quo" problems are compounded by disproportionate capital allocation or "weighting." The larger the market cap of the company, the larger its weight in the index. As the stock price rises, the increased market cap weight forces index funds who already hold the component, large and small, to buy more of the company shares.

Ceteris paribus, value investors buy more as prices decline, while market cap weighted index funds do exactly the opposite, buy more of what they already hold, at prices rising higher and higher. Thus, the owners of 20% of corporate America, not only control the boardroom, but they are disproportionately misallocating capital as momentum rather than value investors. As stock prices and the indices rise, this forced buying herd behavior, amplifies the risk of overvaluation in heavily weighted...


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