Agora Financial’s Rude Awakening

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Baltimore, Maryland

• Modern “free-form merchants” and how you can invest with them,
• One nimble investment likely to prosper as others go cold turkey,
• Too much of an already bad thing and plenty more…

Joel Bowman, reporting from Taipei, Taiwan…

We’ll float around, and hang out on clouds,
Then we’ll come down, and have a hangover

- Kurt Cobain, Dumb

It is often said that the first step to recovery is admitting you have a problem. “Denial is not just a river in Egypt,” goes the old saw. Addicts will contest that it is, of course…further proving the point.

Some addicts manage to maintain what is known (mostly only to them) as a “functioning addiction,” meaning they are able to perform day to day tasks under the influence of their object of addiction. Others, including the myriad, over-romanticized league of artists who fall victim to substance abuse, never really recognize their condition for what it is. And still others, like the gentleman who provided today’s opening quote, become so frightened/defeated when they examine their addiction closely, they promptly stuff the barrel of a 12-gauge shotgun down their throat and end it all there and then.

It is no secret to readers of these pages that the U.S. economy has spent the better part of the last two decades nursing a robust addiction to cheap credit. On a few occasions it looked as though the economy might be forced to kick its filthy habit, to pay back what it owed and start afresh. But whenever things got a tad tough– say, in the long nights of 2001-‘02, when the market was desperately trying to correct itself and “go straight” – the Federal Reserve was waiting in the ally with an irresistible vial of the good stuff.

Now things have come to a head. Other members of the international community, particularly those with significant investments in the U.S., look disapprovingly at what America is doing to itself, in particular, its flagrant currency abuse. China, for one, has begun staging an embarrassingly public intervention of sorts, urging America to control itself and stop freebasing/debasing its currency.

Will the credit-addled child execute its promised “exit strategy” before the 12-gauge begins to appear a better option than sobriety? Only time will tell.

As for consumers, they’ve already been forced into a kind of compulsory withdrawal. As noted economist, Gary Shilling, president of A. Gary Shilling & Co., explained to Bloomberg earlier this week:

“Consumers simply have no borrowing power, so they have no choice but to retrench and, as they retrench of course that pushes the economy down…they’re 70% of GDP, they retrench, [so there is] less spending, less need for goods, less need to employ people, layoffs, more waste cuts, etcetera. It’s a vicious circle.”

Indeed it is, and no doubt consumers are sweating it out without easy access to layaway luxuries. But what about all that stimulus out there on the street, folks say. Isn’t that, like some kind of financial methadone, helping to sate the cravings?

“The fiscal stimulus so far is doing nothing,” Mr. Shilling continued. “The administration can’t come out and say spend, spend, spend…but why pump out all this fiscal stimulus if they don’t expect people to spend it? He [President Obama] wants to get that money out faster but, the point is now people are simply saving it…they’re doing what they haven’t done in 25 years: they’re going on a savings spree.”

What of the great consumer economy when the consumers economize? we wonder.

Our guess is that businesses that rely on the sale of expendable items will continue to suffer, while tightly managed outfits with sound cash flow that are based on providing necessary goods and services will thrive. In the column below, Chris Mayer walks us through one investment he believes will excel while others are left to suffer through cold turkey. Enjoy…

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If Stocks Terrify You, Buy This
By Chris Mayer

You might call them “free-form” merchants. They did a little bit of everything, as opportunities presented themselves. In the 18th century, you could find such merchants in seaports up and down the East Coast, from Boston to Charleston.

Such a merchant might arrange voyages to Africa or the Far East – hire a captain, underwrite the insurance and divvy up the profits. He might deal in shares of land companies or bonds. He might lend money, trade grains, sell lottery tickets – whatever. These merchants were not committed to a single business. They would go where the best of it looked to be. They were opportunists in the best sense of the word.

Throughout financial history, you can find their likeness all over the world – even as far back as ancient Rome and Greece…or ancient Egypt, Mesopotamia and Persia. And in more modern times, you find their likeness in conglomerates – holding companies that deal in many different businesses. Run by a talented team – guided by solid investing principles – such a “does anything” structure can lead to great long-term track records of wealth creation for its shareholders. The old Teledyne, created by the late great Henry Singleton was one of the best. Warren Buffett’s Berkshire Hathaway is another modern example.

And I’ve recommended a few of these free-form merchants to the subscribers of Capital & Crisis. One such company is Loews Corp. (L: NYSE), which is celebrating its 50th anniversary. Run by the Tisch family, which holds more than 20% of the stock, Loews has generated an annual return of 16% over those 50 years, compared with only 5.7% for the S&P 500. Of course, the past is no predictor of the future, but I like the philosophy and investments here. At today’s price, picking up Loews’ stock is like picking up free money, as I’ll show you.

The mix of assets has changed over time. Loews once owned movie theaters and supertankers, for instance. Not today. Last year, it dumped its tobacco company and picked up a natural gas explorer and producer. The Tisches are free to go where the opportunity is.

There are several things I really like about how the Tisches manage Loews, beyond the flexibility of the conglomerate approach. Two in particular stand out:

Share repurchases. Over time, Loews has cut the numbers of shares outstanding by buying back stock from time to time. Loews reduced its share count by 18% in 2008 and 30% since 2000. That means that over time, you own a bigger stake in the company. This is in great contrast to many companies in which the opposite is true. When share counts rise, that is dilution for the existing shareholders. Same assets, but now you share them with a lot more people.

This is one aspect of investing that most people simply do not follow much, but one that I pay a great deal of attention to. I have no use for managers who treat their shares like candy they hand out to themselves and their friends. In my book, Invest Like a Dealmaker, I cite research that shows how low price-to-book stocks with falling share counts beat out those where share counts rise. Respect the share count. Loews does that.

Additionally, I like how the Tisch’s commit themselves to maintaining an excellent financial condition. That means lots of cash and liquidity. I find it impressive that in 2008 – when most everyone was scrambling for cash – Loews was able to invest $2.5 billion and still finish the year with $2.3 billion cash at the holding company level.

Perhaps best of all is the value you get in owning Loews stock. Today, the company has three publicly traded subsidiaries. It owns 90% of CNA Financial, a large insurance company with ample levels of liquidity. It owns 50.4% of Diamond Offshore, a driller with sales of $3.5 billion last year and a backlog of $10 billion. It also has $700 million in cash and no debt. And Loews owns 74% of Boardwalk Pipeline. Boardwalk has over 14,000 miles of pipeline in some of the most prolific natural gas basins in the country – the Barnett Share, Fayetteville, Haynesville and other places.

Forget that these investments are cheap in their own right. After all, Diamond Offshore is priced at less than half of its high and trades for only 8 times earnings. Boardwalk is nearly half its recent high and pays 9%. CNA is a third of its 52-week high and half of book value. Let’s just accept today’s market prices. Based on those market prices, the Loews’ stock price of $28 equals those investments.

Of course, Loews owns more than this. Loews owns HighMount Exploration, a natural gas company with 2.2 trillion cubic feet of reserves. HighMount probably chips in another $3.50 per share in value. Then there is the net cash, plus general partnership interests, preferred stock and Loews Hotels. The value of all these private investments is around $12-13 per share, by my estimate. That means Loews stock is worth at least $37-38 per share – even in this depressed environment.

With Loews at $25 per share as I write, the stock market is telling you that portfolio of private investments is worthless. Looks like a buy to me.

As I think about this crazy market, I don’t mind putting some dough with guys who’ve produced superior long-term track records, who’ve lots of cash and who pursue an investing philosophy I can warm up to. In this case, we also get in at a cheap price.

There is certainly a lot going on the market today – plenty to chew on and figure out. I look forward to seeing how it all unfolds. In the meantime, I feel good about investing alongside proven operators like Loews’ management.

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[Rude Endnote: Just in case you’re interested, Princeton University’s very useful WordNet page provides the following definitions for addiction:

S: (n) addiction: being abnormally tolerant to and dependent on something that is psychologically or physically habit-forming (especially alcohol or narcotic drugs)

S: (n) addiction: an abnormally strong craving

But it is this third definition that we found most fascinating…

S: (n) addiction (Roman law) a formal award by a magistrate of a thing or person to another person (as the award of a debtor to his creditor); a surrender to a master. “Under Roman law addiction was the justification for slavery“

A sign of things to come?

We’ll be back with more tomorrow.

Until then…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com