CFA Japan Seminar on September 19, 2019 - Cross-Capital Analysis and Investing - Prof Joel Litman -

Valens Research - CFA Japan - Cross-Capital Analysis and Investing - Prof Joel Litman - 2019 09 19

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1. Professor Joel Litman v.2014 04 12 FIDO VALENS RESEARCH Cross-Capital Investing Credit to Equity – Equity to Credit Joel Litman September 2019 Valens Research 110 Cambridge Street, Cambridge, Massachusetts 02141 joel.litman@valens-research.com PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
2. “Without a firm handle on credit analysis… …we'd argue you can't fully understand the wealth-creation process as an equity investor.” Mitch Julis Canyon Capital PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
3. PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
4. “Without a firm handle on credit analysis… …we'd argue you can't fully understand the wealth-creation process as an equity investor.” Mitch Julis Canyon Capital PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
5. PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
6. 6 "If the rating agencies will downgrade only when we can all see the losses, then why do we need the rating agencies?“ - Jim Chanos, the head of Kynikos Associates “…the ratings that were developed by the credit rating agencies were a major factor in the cause of the problems…” - Federal Reserve Chairman Alan Greenspan re: the 2007-2009 crisis "The ratings agencies, basically, without looking at the underlying bond, they just pretty much gave almost everything that came out AAA ratings,“ - Smith, West Virginia Labourers Trust Fund, $300 million pension fund PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
7. PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
8. Credit Protection Buyer e.g. Owner of the bond Pays for the CDS Recovers loss if bond issuer defaults Credit Protection Seller e.g. “Insurer” of the Bond Sells the CDS Pays for loss if bond issuer defaults Credit Default Swap bps per year $$ of loss PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
9. <-> ? PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
10. CDS vs. Avg Credit Rating 1,216 Companies Worldwide with CDS and Credit Rating 0.00 500.00 1,000.00 1,500.00 2,000.00 2,500.00 3,000.00 3,500.00 4,000.00 4,500.00 0 . 0 0 2 5 . 0 0 Credit Rating from AAA+ to C- Credit Default Swap (5 Yr bps) 2008 Feb 8 AAA C June 18, 2008 Presentation PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
11. 11 AMD PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
12. 12 AMD: In 2007, AMD held up at $13 Stock Price PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
13. 13 AMD: Meanwhile, CDS had climbed to 600bps Stock Price CDS PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
14. 14 AMD: A history of terrible cash flow returns ADVANCED MICRO DEVICES IC' Growth 0% 23% -7% 18% 32% 5% -33% 13% 10% -6% 2% 9% 3% 2% -40% -20% 0% 20% 40% 1999 2000 2001 2002 2003 2004 2005 2006 2007 LFY+1 LFY+2 LFY+3 LFY+4 LFY+5 ROI' -6% 4% 0% -9% -4% -1% 0% 3% 0% -20% -10% 0% 10% 20% 30% 1999 2000 2001 2002 2003 2004 2005 2006 2007 LFY+1 LFY+2 LFY+3 LFY+4 LFY+5 PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
15. 15 AMD: At $13.50, a significant turnaround was priced in… ADVANCED MICRO DEVICES IC' Growth 0% 23% -7% 18% 32% 5% -33% 13% 10% -6% 2% 9% 3% 2% -40% -20% 0% 20% 40% 1999 2000 2001 2002 2003 2004 2005 2006 2007 LFY+1 LFY+2 LFY+3 LFY+4 LFY+5 ROI' -6% 4% 0% -9% -4% -1% 0% 3% 0% 2% 4% 6% 8% 10% -20% -10% 0% 10% 20% 30% 1999 2000 2001 2002 2003 2004 2005 2006 2007 LFY+1 LFY+2 LFY+3 LFY+4 LFY+5 PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
16. 16 AMD: If cash flow will really grow, why 600bps CDS? ADVANCED MICRO DEVICES IC' Growth 0% 23% -7% 18% 32% 5% -33% 13% 10% -6% 2% 9% 3% 2% -40% -20% 0% 20% 40% 1999 2000 2001 2002 2003 2004 2005 2006 2007 LFY+1 LFY+2 LFY+3 LFY+4 LFY+5 ROI' -6% 4% 0% -9% -4% -1% 0% 3% 0% 2% 4% 6% 8% 10% -20% -10% 0% 10% 20% 30% 1999 2000 2001 2002 2003 2004 2005 2006 2007 LFY+1 LFY+2 LFY+3 LFY+4 LFY+5 PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
17. 17 AMD: Months later, CDS continued to climb to over 1000bps Stock Price CDS PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
18. 18 AMD: And stock price… Stock Price CDS PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
19. “Identify the accounting issues you see at the business… The credit investors will understand what that means for the credit.” Mitch Julis Canyon Capital PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
20. On bankruptcy fears, AMD traded down to less than $2.50 Cash From Operations as- reported was negative In reality, cash flow from operations was over $1Bn PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
21. Data as of Nov 2016 As-reported CFFO is terribly mis-reported. On bankruptcy fears, stock traded less than $2.50 Credit fears subsided, stock surpassed $15 PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
22. “Internally inconsistent” “Misleading” “Confusing” “Inaptly named” “…likely to be misunderstood…” FASB Members, Lauver, Leisenring. Swieringa Referring to The Statement of Cash Flows PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
23. POP QUIZ: Where would you place interest expense in the Cash Flow Statement? PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
24. POP QUIZ: Where would you place Rental Financing in the Cash Flow Statement? PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
25. POP QUIZ: Where would you place R&D Investments in the Cash Flow Statement? PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
26. POP QUIZ: Where would you place Cash Flow From Acquisitions in the Cash Flow Statement? PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
27. Japan Tobacco: As-reported CFFO Versus Uniform CFFO PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
28. PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
29. PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
30. “People who use EBITDA are either trying to con you or they’re conning themselves.” Warren Buffett PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
31. PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
32. “The ‘horrors’ of EBITDA have been understated as has the disgusting nature of the people that brought that term into the valuation of business.” Charlie Munger PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
33. PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
34. “It is not clear why investors suddenly came to accept EBITDA as a measure of corporate cash flow. EBIT did not accurately measure the cash flow from a company‘s ongoing income stream. Adding back 100% of depreciation and amortization to arrive at EBITDA rendered it even less meaningful.” Seth Klarman PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
35. PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
36. GAAP distortion examples as of March 2015 DAL • Capitalized leases of 398mm vs. 1,200mm • Pens Exp 885mm vs. 603mm vs. ZERO • ROA of 6% versus Adjusted ROA’ of 14% • P/E of 9 versus Adjusted P/E of 20.5 PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
37. Source: Valens Credit Analysis PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
38. Source: Valens Credit Analysis PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
39. Source: Valens Credit Analysis PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
40. Intrinsic Credit Default Swap (iCDS 5yr) Source: Valens Credit Analysis PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
41. UAFRS-based PAYMENT CUSHION Source: Valens Credit Analysis PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
42. Source: Valens Credit Analysis UAFRS-based CASH TO DEBT LEVELS PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
43. UAFRS-based DEBT REPAYMENT SCORE Source: Valens Credit Analysis PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
44. Source: Valens Credit Analysis UAFRS-based ROA’ TREND PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
45. ADJUSTED TOTAL DEBT & RECOVERY RATE Source: Valens Credit Analysis PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
46. Intrinsic Credit Default Swap (iCDS 5yr) PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission. Source: Valens Credit Analysis
47. “It's in the interest of Wall Street, enormously, to focus on something called EBITDA because it results in higher borrowing power, higher valuations, and all of those sort of things.” Warren Buffet Chairman and CEO, Berkshire Hathaway PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
48. “So it’s [EBITDA] absolutely insane. And of course, it was a bunch of investment bankers that invented it to make their trade easier. And it’s disgusting.” Charlie Munger Vice Chairman, Berkshire Hathaway PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
49. M Actu Intrin Price 0 2 4 6 8 10 12 14 16 Price 0 100 200 300 400 500 600 700 800 900 Actual Intrinsic STOCK PRICE CDS And iCDS PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
50. STX STOCK PRICE CDS And iCDS PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
51. Actu Intri Price 0 5 10 15 20 25 30 35 40 Price 0 200 400 600 800 1000 1200 Actual Intrinsic STOCK PRICE CDS And iCDS MT PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
52. PALM STOCK PRICE CDS And iCDS PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
53. CDS vs. Avg Credit Rating 1,216 Companies Worldwide with CDS and Credit Rating 0.00 500.00 1,000.00 1,500.00 2,000.00 2,500.00 3,000.00 3,500.00 4,000.00 4,500.00 0 . 0 0 2 5 . 0 0 Credit Rating from AAA+ to C- Credit Default Swap (5 Yr bps) 2008 Feb 8 AAA C June 18, 2008 Presentation PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
54. PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
55. Credit Default Swaps → Corporate Interest Rates PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
56. U.S. Corporate Return on Assets (ROA’) U.S. Corporate Value/Earnings Ratio (V/E’) 7% 8% 7% 6% 8% 8% 9% 10% 10% 9% 8% 10% 11% 11% 10% 9% 10% 10% 11% 12% 12% 13% 11% 0% 5% 10% 15% 20% 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019E Mkt Imp ROA' Source: Capital IQ, Valens Research Analysis (2,767 US Corporation Aggregate) Data Date: 3-May-2019 27.7 31.5 30.8 21.3 20.4 19.4 17.6 18.0 20.5 18.5 15.7 15.4 15.4 17.1 20.8 22.7 22.5 21.9 21.9 21.5 21.4 0 10 20 30 40 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019E Fwd V/E' PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
57. How many are hurt by the tariffs? PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
58. Which are most affected by tariffs? PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
59. How many benefit from a ~50% tax cut? PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
60. U.S.Corporate Return on Assets (ROA’) U.S. Corporate Value/Earnings Ratio (V/E’) 2,771 U.S. companies (non-financial) 7% 8% 7% 6% 8% 8% 9% 10% 10% 9% 8% 10% 11% 11% 10% 9% 10% 10% 11% 12% 12% 13% 11% 0% 5% 10% 15% 20% 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019E Mkt Imp ROA' Source: Capital IQ, Valens Research Analysis (2,767 US Corporation Aggregate) Data Date: 3-May-2019 27.7 31.5 30.8 21.3 20.4 19.4 17.6 18.0 20.5 18.5 15.7 15.4 15.4 17.1 20.8 22.7 22.5 21.9 21.9 21.5 21.4 0 10 20 30 40 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019E Fwd V/E' PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
61. Professor Joel Litman v.2014 04 12 FIDO VALENS RESEARCH Cross-Capital Investing Credit to Equity – Equity to Credit Joel Litman September 2019 Valens Research 110 Cambridge Street, Cambridge, Massachusetts 02141 joel.litman@valens-research.com PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.
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