Transaction Alert: Bought HAWK

This post is a couple days late, so my apologies. On 7/7/2010 I purchased 1000 shares of Seahawk Drilling, symbol HAWK, for $9.10 a share. As with most purchases, this new holding makes up about 10% of my portfolio.

By way of background, HAWK is a shallow water offshore drilling company in the Gulf of Mexico. They became a public company in August 2009 after being spunoff from Pride International. In addition to the typical market inefficiencies that can accompany a spinoff, the BP Gulf disaster has contributed to make the price of HAWK shares very very cheap IMO.

I've been following HAWK since it was spunoff almost a year ago, and as a result I stumbled upon an excellent blog, http://greenbackd.com/. Greenbackd's analysis of HAWK is perhaps the single best write up I've ever seen on a blog - this is serious stuff here, in fact it's more insightful and intelligent than just about any Wall Street report I've read (and I've read quite a few). So, rather than try to do my own write-up (which would pale in comparison), I'm just going to link to Greenback'd's.

• An introduction (September 2009): http://greenbackd.com/2009/09/08/guest-post-ben-bortner-on-seahawk-drilling-nasdaqhawk/
• Revisited (June 2010): http://greenbackd.com/2010/06/03/seahawk-drilling-nasdaqhawk-redux/
• Parallels between HAWK and Mohnish Pabrai's investment in FRO, very insightful (June 2010): http://greenbackd.com/2010/06/04/pabrai-on-frontline-ltd-usa-nysefro-hawk-template/
• HAWK liquidation value (June 2010): http://greenbackd.com/2010/06/30/hawk-liquidation-values/
• Rig value (July 2010): http://greenbackd.com/2010/07/06/hawk-rig-market-values/

The above links are a long read, so here is a summary of the most pertinent information I used to make my decision:

• HAWK is probably worth $154 MM in a forced liquidation scenario where it's rigs are sold as scrap. However, even in this type of scenario the rigs would probably be sold as operational, in which case the liquidation value is probably closer to $300 MM. (As of 7/9/2010, at a stock price of $10.71, HAWK had a market cap of $126.6 MM!!)
• In the good old days (2006 to 2008), HAWK generated a pro forma net income in the $150 MM range on an annual basis. It probably won't ever get back to those results, but given it's PE ratio is less than 1x peak earnings shows how cheap the stock has become.
• On July 29th, an 8K was filed that basically said the CEO and board members wouldn't receive a cash salary for the rest of 2010, but rather they would get an equivalent amount of restricted stock based on the June 25th closing price - so effectively they're "buying" a huge slug of stock. However, what's so interesting about this isn't the stock "purchase," but rather the timing - ALL of the stock is being awarded at the June 25th price (as opposed to a monthly price). If I were to read between the lines my guess would be management thinks the stock is CHEAP and it's NOT going to stay this cheap for long.

So, that's basically my investment thesis boiled down to a couple of bullet points. In a way, HAWK reminds me of my experience with USG. I purchased USG in March of 2009 when the outlook couldn't have been bleaker for the home builder supply industry. Things didn't get materially better, BUT the outlook went from bleak to slightly-less-bleak, and the stock went from a purchase price of <$5 to a selling price >$21 over my 13 month holding period. Will HAWK do the same? (Obviously I have no idea, but I've placed my bet!)

My Returns as of Q2 2010

I started 2010 with $107,514 in my portfolio and finished the quarter with $101,294. I didn't make any deposits or withdrawals, so the decrease in value was driven by a decline in aggregate of my stocks.

• On an absolute basis, my portfolio declined 5.8% during the first two quarters of 2010. Annualized, this rate of return is -11.3% (although negative, this is still slightly better than the S&P).
• I've been tracking my returns for 4 years and 6 months, during which time my annual rate of return is 13.4%. Over the same period the S&P returned -1.9% annually. In other words, over 4 and half years I've outperformed the S&P by over 15% annually.

Obviously, beating the S&P by 15% every year is quite good. HOWEVER, as I've said before, I have a very concentrated portfolio - a few good picks can make a huge difference in performance - so I still have no idea whether I'm just lucky or if I'm doing something right...

Sucker's Rally?

It's been awhile since my last post, so I apologize to my regular readers - I think there are 2 of you :)

Last week I read a fascinating article in the Huffington Post, entitled "Remember: In 1930, They Didn't Known It Was 'the Great Depression' Yet" (http://www.huffingtonpost.com/henry-blodget/remember-in-1930-they-did_b_605814.html). I highly recommend reading it in its entirety, but the basic gist is after the 1929 crash there was brief period defined by renewed optimism, speculation, IPO's, etc. which of course turned out to be a sucker's rally.

Basically, the market went from its 1929 peak of 381 to an initial bottom of 199. This was followed by a rally that pulled the market all the way to 294 over the next six months. Finally, after this "sucker's rally" the market once again turned negative and bottomed out at 42 eight months later (that's right, 42!).

The point of the article is to draw similarities between what's unfolding today and what happened back then - was it a sucker's rally when the DOW went from its March 2009 low of 6.5K to its May 2010 high of 11.2K? Should we expect the market to hit new lows over the coming months and years?

Obviously I have no clue.

Interestingly enough, George Soros recently gave a speech in which he elaborated on this very subject (http://www.gurufocus.com/forum/read.php?1,97265,97464#msg-97464). During this speech, he said such warm and fussy things like:

• The current situation in the world economy is “eerily” reminiscent of the 1930's with governments under pressure to narrow their budget deficits at a time when the economic recovery is weak.
• “The collapse of the financial system as we know it is real, and the crisis is far from over. Indeed, we have just entered Act II of the drama.” (Act I is defined by replacing private debt with public debt, "thereby reinforce[ing] the excess credit and leverage that had caused the crisis in the first place." Act II began "when financial markets started losing confidence in the credibility of sovereign debt," with Greece and the Euro taking center stage.

So if the bear case I described above does indeed come to pass it could mean very bad news for the average Joe who invests in common stocks (i.e. me). The question is how should one position their portfolio if they believe there's a 10% chance it'll play out (or 25%, or 5%, etc.)? Remember, there's always a chance that we make it through this mess unscathed, and if you hold too much cash you could miss out on significant upside...

Personally, I've got about a third of my portfolio in cash. Not only does this act as a safety blanket should things head south, but it will also give me the opportunity to snatch up some bargains in this scenario. Conversely, the other 2/3rds of my portfolio is spread over a small handful of stocks that I feel are undervalued in aggregate, so should the market rally I feel these securities will do quite well.

Transaction Alert: Bought AHS

When I sold SandRidge Energy (SD) last Friday I used the proceeds to immediately buy AMN Healthcare Services (AHS). I purchased 1200 shares, for a total outlay of about $9,600. The stock is currently at $8 a share, but I think it's worth about $15 to $20.

AHS is a staffing company for nurses and other healthcare workers. They are somewhat economically sensitive, and as a result their revenue fell from $1.2B in 2008 to $760MM in 2009. However, AHS generally produces pretty stable EBITDA margins in the high single digits, for 2008 their margin was 7.9% and for 2009 it was 7.5%.

I expect their revenue to rebound to about $1B within a year or two and probably grow at 5% to 10% thereafter. At $1B in revenue I conservatively expect them to generate about $70MM of EBITDA. With this type of margin/growth profile I think a EV/EBITDA ratio of 10x is quite reasonable, which implies an EV (enterprise value) of $700MM. Their current EV is just over $300MM, so it's really not much of a leap to get to my fair value range of $15 to $20 a share.

From a high-level perspective this new purchase did not alter my portfolio very significantly. I made the AHS purchase with cash from the sale of SD, so I'm still about 30% cash.

Transaction Alert: Sold SD

On Friday (May 21st) I made the tough decision to sell my shares of SandRidge Energy. I still think the stock is significantly undervalued BUT I'm also concerned there's a lot of downside risk, specifically:

1. A lower outlook for oil prices.
2. High leverage and a diluted shareholder base due to an ill-timed acquisition.
3. My portfolio already has significant exposure to the energy sector.

The SandRidge acquisition of Arena Resources will shift the company's focus to oil and away from natural gas in a significant way. Unfortunately, SandRidge made its bid when the price and outlook for oil was significantly higher - if the price of oil stays at its current level there's a very real possibility this merger will destroy shareholder value. If the price of oil falls further SandRidge could experience financial distress.

SandRidge is a very hard company to value - when I initially purchased the stock my estimate of the fair value was somewhere from $10 to $20 per share. Currently I think it's more like $5 to $15, but there's also a very real chance it could be worth even less. Ultimately, the risk/reward isn't as attractive as it used to be, but I'm going to keep an eye on SD b/c there are still a number of attributes that could make it a good investment.

Random Musings

A little over a month ago I wrote a post entitled "Feeling Fearful" (which can be found here http://mevsemt.blogspot.com/2010/04/feeling-fearful.html). During this time I sold several stocks (SHLD and USG) and allocated about 30% of my portfolio to cash - in retrospect, it looks like my timing couldn't have been more lucky. Since then, the market has turned decidedly more fearful as the Eurozone mess has drawn an increasing amount of investor attention and oil gushes into the gulf.

Ironically, the oil spill disaster could prove beneficial for some of the stocks I own. A likely consequence of this mess is increased government regulation and decreased offshore drilling in the short to medium term. This in turn could lead to an increase in the price of oil and natural gas (natural gas in particular, b/c it can't be imported from overseas nearly as easily). IF this does indeed play out I'd expect SD, GMXR, and EXC to reap the benefit (SD and GMXR have onshore operations and EXC would benefit from an environment with higher energy prices in general).

On a negative note I expect the call options for FAF to expire worthless. In my initial post I wrote that a broad market sell off could cause this, and of course within a couple days the market began selling off...

HOWEVER, I think any further market sell off could present an attractive buying opportunity. So, with about 30% (about $34K) of my portfolio in cash, I am constantly refining and evaluating my watch list. Current stocks that I find interesting include BAX, APOL, CNX, GENZ, AHS as well as existing holdings SD, GMXR, and EXC.

As always I'll post about any transactions.

Transaction Alert: Exelon LEAPS Part 2

I just bought 10 contracts for EXC January 2012 $50 Calls at $2.00. I previously purchased 10 identical contracts earlier in the month, the only difference being that I paid $2.10. So, now I have a total of 20 contracts for EXC January 2012 $50 Calls.

Transaction Alert: FAF Call Options

On Friday I purchased 2 sets of call options in FAF for a combined outlay of about $2,000. The first was 10 contracts of FAF October 2010 $40 Calls at $1.10 and the second was 20 contracts of FAF June 2010 $37.50 Calls at $0.50. The price of FAF is currently around $35 a share, so both these call options are currently "out of the money."

This bet falls a little outside the realm of normal value investing. FAF is splitting into 2 companies on June 1st, one that focuses on title insurance and another that focuses on information services. My current thinking is that FAF has a fair value of about $50 a share, and my hope is the spinoff will act as a catalyst for FAF shares to appreciate.

The danger with this investment is that it's very short term - so if there's a broad market selloff these options could easily expire worthless. On the flip side, if the market rallies in the near term these options could be worth a lot of money.

In conclusion, this "investment" is 1/3 special situation, 1/3 value investing, and 1/3 luck - my guess is there's a 50% it'll make money and a 50% chance it won't. HOWEVER, if it does make money it'll be 3x to 4x my initial investment, which is why I felt comfortable making the bet in the first place.

Transaction Alert: Exelon LEAPS

I just purchased my first option - 10 contracts of "EXC January 2012 $50 Calls at $2.10." In other words, anytime between now and January 2012 I have the right to buy shares in Exelon for $50. Each contract includes 100 shares, and I bought 10 contracts, so my sunk cost in this investment was $2,100 (plus a small commission of ~$11).

Since the contract price was $2.10, I make a profit if the share price exceeds $52.10 (50+2.10). Due to the leveraged nature of LEAPS, for each incremental $1 above this price I make a $1,000 profit! My hope is the economy continues to rebound and both power prices and energy consumption rise along with it. If this happens my guess is EXC could be worth $60 to $80 a share, which would generate a profit of $7,900 to $27,900, respectively - not bad for a $2,100 investment.

On the other hand, there is a decent chance my investment thesis could be flat-out wrong. If this is the case and EXC never gets above the $52.10 threshold then I only stand to lose $2,100.

Time to lever up?

LEAPS, or Long-term Equity AnticiPation Securities, have recently grabbed my attention. LEAPS are simply a long-term call option, or in other words the right (but not obligation) to buy a stock at some point in the future at a predetermined price.

Here's an example: let's say stock XYZ is being investigated for some alleged wrongdoing. Currently the stock is trading at $100 a share, but it's worth $200 assuming they're innocent. However, if they're guilty the stock is probably only worth $50. If I were to purchase XYZ common stock, based on my current portfolio size, I'd probably buy $10,000 - and I'd either lose $5,000 or gain $10,000.

However, let's say I could buy XYZ LEAPS (expiring 1/2012) with the following terms: a strike price of $150 and a contract price of $5. In other words, for $5 I reserve the right to buy one share of XYZ for $150 anytime between now and 1/2012. If I were to invest $5,000 in XYZ LEAPS I could potentially lose it all if the stock never gets to $150 (which is the same amount I'd lose with the common stock).

But what happens if the stock goes to $200? Well, since I invested $5,000 I have the right to buy 1,000 shares at $150. Since I could immediately sell them for $200, I'd realize a $50,000 profit! So, with LEAPS I'd either lose $5,000 or gain $45,000 (50K profit less the initial investment of 5K).

Obviously this is a very simplistic example - the real world is much murkier. However, the economics of buying LEAPS can be extremely attractive, and in some cases it just makes more sense. I'm specifically looking at Jan. 2012 LEAPS for EXC and MON and as always I'll post about anything I decide to do.