Wednesday, August 21, 2013

Excel data table for sensitivity analysis

I've used Microsoft Excel for so long that it has become kind of like another appendage at work. It is one of the most powerful tools you can learn to use to increase your productivity in an office. I played a lot of video games growing up, and in video game terms increasing your Excel skill is kind of like adding experience points and making your character more powerful. The better you know how to use excel, the more you can do in less time, especially if you're in finance/accounting/marketing/other numbers-oriented fields (and these days with rise of big data, almost every field is now numbers oriented). Every day I learn a new function, re-learn how to use an old one that I haven't tried in a while, or discover a new way to do something quicker.

One powerful tool I use often enough to have memorized how to use it is the data table function. Let me put its usefulness in context...

So you've created a working DCF model that values a company and you've assumed a discount rate and a revenue growth rate as part of this. Your boss/portfolio manager/wife/self looks at it and says "ok, but a DCF is just a tool to estimate value. You're giving me an precise number. How sensitive is that number to the discount rate you chose? By the way I don't believe the revenue growth rate you chose- what would the value look like if you dropped it by 5%?"

You go back to your spreadsheet and build a table. You spend the next hour methodically changing the discount rate input, and the earnings rate input, and noting the results. You come up with a whole range of values. You format them nicely, print it out and show your boss/portfolio manager/wife/self. He/she says "great, this is what I was looking for. I'm not confident the revenue growth will be as high as it needs to be to make a good return buying the stock at its current price so I'm not sure what to do here. How about you change the margin assumption in your model and show me what it does to this sensitivity table?"

You sigh. It's six o'clock. It will take another hour to do this, but you go back and make the change to your margin assumption. You then slog through, methodically changing the discount rate and the revenue growth rate and noting the results. You think about that beer waiting for you at home. Your mind wanders and you wonder if Excel has a way to automatically create a data table that will be sitting there, ready to update at a second's notice if you change any part of your model. One that will vary the assumptions for you behind the scenes and print out the results for you... 

You fire up the google. Your hard drive and RAM are jolted with electrical impulses. The google algorithm does your bidding. It sorts, it seeks. Your ISP brings you data at your maximum download speeds, your monitor renders bits and bytes into pleasing words and pictures.... and one second later you get search results. Pages upon pages of search results, all of them pointing you to the data table function. You fire up youtube, watch a tutorial, and seconds later you have a dynamically linked sensitivity table ready to do your bidding at a moment's notice. It takes a bit of time to get it right- some videos only use a single variable analysis, you keep getting the row and column inputs confused.... but it is time well spent. Learning how to use a data table just shaved an hour off of every future DCF you do. It made you more efficient. It made you better at your job. 

Anyway, if you haven't learned this yet, I strongly suggest you check out how to create a data table in Excel. Yes it is a bit complicated at first, but it gets much, much easier. 

As a side note, I've found the best way to learn how to do things in excel is with actual live problems. Something that you need to deliver and that would be mind-numbingly tedious without an excel trick. 

I suck at using blogger for anything but text, so as of now I'm not able to give you an effective tutorial on how to use data analysis (apologies to anyone who came here looking for this). What I can say is that there are hundreds of demos just waiting for you on google. I tend to prefer a youtube demo because you can see how people do things live, which helps you understand what you may be doing wrong when you mess up. 

I just did a quick search and thought this demo was pretty good.

Have fun.

Thursday, July 18, 2013


As many advanced googlers know, if you type in a search term with a minus sign before it, your search will not return results with that word in it. I was just sitting here doing a thought experiment- what if I spent the next few weeks only reading financial news stories/research/information that do not contain the word "bernanke." Better yet, what if I could just run the big "minus" filter on a host of terms including "qe," "fed," "gold," and also "bubble" for good measure.

I probably wouldn't be able to visit zerohedge anymore, which would be a bummer because that is one of my favorite sites.

I know this whole thing is in uncharted waters currently, but Every now and then don't you get bernanke fatigue? Fiat fatigue? Maybe it is just a part of getting older. Maybe my father was in this position 30 years ago when he was looking at the economic future of the country and hearing doubts about where it was going to be in 30 years. Maybe you can always find things to worry about.. Maybe my father had Volker fatigue in 1983. Maybe things have never looked good to anyone and all of us current market participants are just in the same position our fathers were in. Maybe it is time to stop worrying about it so much.

I know you can respond with umpteen stats about how this time it's different. How the gap between the rich and the poor has steadily increased, and how incomes have come down (or if you want to make the argument they've gone up in aggregate). Don't bother making them to me though. At this point I tend to just nod my head when I hear someone's prediction about where the economy and the country are headed.

I'll continue to read about and follow it all because that's the way I'm wired, but boy a vacation would be nice. 

Thursday, February 21, 2013

Thoughts on 3G Capital's LBO of Heinz or "Warrant" Buffett Strikes Again

On Feb 14 (last Thursday), Berkshire and 3G Capital announced that they agreed to acquire food company H.J. Heinz Co. for $23 billion in cash ($72.50 per share, a 20% premium to where the stock closed the day before).

Well, that's what the headlines would have you believe anyway. However, that is not what is happening. My headline is a bit more accurate. I'll explain below.

Initial read

I was pretty busy last Thursday so I didn't pay a whole lot of attention to the acquisition, but as may you know I'm a big Buffett buff and I made a mental note to take a closer look at the numbers at some point in the future. I like to check in on what smart people are valuing businesses at every now and then so I have a good market reference point in my head.

My initial assumption based on the headlines alone was that the deal made sense- Buffett loves these big, high quality brand name companies and Heinz seems to make sense as a piece of the portfolio alongside Wrigley, Coke, and Gillette. I also know Buffett likes to pay a reasonable for a business (read basically any book about him and you'll see some reference to the "margin of safety" concept he learned from Ben Graham) so I assumed that he got a good deal. I haven't really followed Heinz, so I thought that maybe the stock had been neglected and possibly didn't take part in the recent market rally.

Today I revisited the story, pulled open Heinz's last 10-K and realized that I was completely wrong. This was not an old-style Warren Buffett margin of safety "be greedy when others are fearful" acquisition of a great business at a substantial discount to intrinsic value. This was much more what I've come to think of as a "new style" Warren Buffett where he gets to put capital to use at rates no mere mortal can obtain. The price paid for Heinz was not a bargain from what I can see.

The price tag was high - 25x earnings!

Looking at Heinz's 2012 10-K (see page 33 for the income statement), the company earned about $939 million of net income for the year ended April 2012. I opened another couple of 10-Ks to look at the five year history, and net income averaged a bit below $939 million for this period, so I figured it was a pretty good number. Divide the purchase price of $23 billion by $939 million and you'll see the Buffett/3G team paid about 25 times trailing earnings for the company, not a low multiple by any stretch of the imagination. For the sake of comparision, Google sells for a similar multiple, is trading at an all time high, and though I'm getting out of my league here, I think it is considered more of a growth stock. Heinz does not make technology, it makes food products.

Going a few pages further in the 10-K, I figured I'd get a rough sense of what the company's free cash flow is. Take net income of $939 million, add back $300 million of depreciation, $50 million of amortization, deduct CAPEX of $400 million and you're at roughly $900 million of free cash flow. If you pay $23 billion for the company, $900 million of free cash flow equates to roughly a 4% yield. The multiple is still about the same, roughly 25x FCF. I also checked how FCF looked over the past five or six years, and again the average was below the current $900 million number.

I didn't create a DCF model of the company because I'd seen enough at this point and I didn't have the time to put into it, but I think if you do a DCF with some reasonable assumptions, you're not going to get to a $23 billion valuation for the company assuming things continue along as they have in the past.

I believe I read in the press that the price was something along the lines of 8x book value and 14x EBITDA, again generally high multiples (though book value isn't the greatest metric for a company like this).

Berkshire didn't buy the company, it bought half of the equity in the deal, plus high-yielding preferred and warrants as a kicker

Reading past the headlines of the articles, I realized that Berkshire's investment in the company wasn't purely an equity stake (like Buffett's investments in Coke, Gilette, Washington Post etc. that he became famous for). Instead, Berkshire is going to pay $8 billion for preferred stock in Heinz yielding 9%, and invest $4 billion of equity.

In addition, 3G is only investing $4 billion of equity and financing the rest. The company is also going to roll its current $5 billion of debt.

So doing some rough math, when the deal is complete, the capital structure will be something like:

$8 billion of equity
$8 billion of preferred stock
$12 billion of debt ($5 billion existing plus ~7 billion of new debt hence the "LBO")

Oh, and if you dig around, Buffett is also getting warrants to buy shares of the company. ("Warrant" Buffett also has Bank of America warrants, had Goldman warrants, and GE warrants). Terms of these warrants weren't disclosed.

Anyway the upshot of all of this is that if the deal is approved, Heinz will become a private company 50% owned by a PE firm with a history of cost cutting. It will have twice the debt load it had previously and its debt will be downgraded by the rating agencies, but as the LBO story goes, should be able to service the debt over time with steady cash flows thrown off by the business. It will enjoy levered returns for a few years, and then 3G will likely look for an exit, possibly selling its 50% stake to Berkshire. The company may be more profitable at that time.

In the meantime, Berkshire rakes in the 9% dividends on the preferred stock. Don't forget that preferred stock dividends enjoy a very favorable tax deduction for corporate owners, so Berkshire also gets to avoid some taxes it would have been hit by had it acquired Heinz outright.

And those warrants. Berkshire can maybe exercise those warrants someday.

Berkshire's price tag - more like 18x earnings, with upside

My final thought- Berkshire's earnings stream from the company will be as follows:

-$8 billion of preferred stock at 9% yield for $720 million a year in pretax preferred dividends
-Since generally 70% of preferred stock dividends are deductible for corporations, the effective tax rate on these dividends will be approximately 10%, for after-tax preferred dividends of about $650 million.
-Plus, Berkshire's 50% share of the company's earnings. This is a harder number to take a guess at but I'll do some extremely rough late-night math. $939 million of earnings in 2012. Subtract preferred dividends of $720 million and this leaves you with about $220 million of earnings. 2012 earnings include about $300 million of pretax interest expense. Since the debt load of the company is going to roughly double, lets assume interest expense doubles, to $600 million (since the rating will fall to junk, the rate on new debt will likely be higher and the cost of rolling old debt will be higher but im not going to get too precise here). Tax effecting the additional $300 million of interest expense at 30%, you get about a $210 million hit to after tax earnings, reducing the $220 million to $10 million of after-tax earnings. Buffett gets the right to half of that, roughly $5 million
-$650+5 = $655 million of after tax earnings per year
-Buffett invested $12 billion of cash
-This results in a P/E multiple of more like 18x earnings. Better than 25, but still not cheap.

Let me know if I missed something. It's late.

Friday, November 9, 2012

Urban Hurricane Preparation

So I've recently lived through the effects of Hurricane Sandy here in the Northeast and I want to give my perspective on how to prepare for a Hurricane if you live in an urban area like me. This isn't a guide per se, but a few things I ran into.

  • Thanks to modern weather forecasting, we knew there was a potential monster storm coming in at least 3 days before it actually hit. My first tip is not to ignore the weather forecasts. Especially if they are dire.  In fact, if you need to guarantee productivity (ie power and internet connection) for office/computer work etc., you might even want to fly you or some of your staff out of town and stay in a cheap hotel somewhere out of harm's way for a week.
  • Gas up. Before the storm comes in, fill your car with gas, and if you have gas cans, fill those also. (Note: if you live in an apartment you likely can't keep gas cans in there due to fumes and general safety. This is more for people with garages and generators. Be extremely careful when storing and transporting gas.) There are long gas lines in NY, NJ and CT at the moment. Bonus points if you have a bicycle that you can attach a basket to for groceries in a pinch so you dont even need to use that much gas.
  • This is an odd one, but something that came up. Your garage door opener might not work after a storm. Go into your garage and pull the disengagement handle for the electronic opening mechanism. You now have an old fashioned door that pulls up and down by hand. Tie a rope with a heavy weight on the end to weigh the door down so it does not blow up in strong winds.
  • A lot of people were so focused on the storm that they ignored the weather forecast for after the storm, which was pretty cold. Be ready to stay warm if needed. Blankets!
  • If you have an electric stovetop, you could be screwed. People with gas at least had something on which to cook, make coffee and tea etc. Ditto for the electric coffeemaker. I highly recommend this regardless of hurricaines, but get an Aerobie AeroPress Coffee and Espresso Maker immediately (check out my review of the aeropress here)!
  • Stock up on dry, canned foods and water. 
  • Stuff sealed ziplock bags mostly full of water into the empty spaces in your freezer. They keep stuff cold longer if the power goes out and in a pinch you can even drink the water.
  • Follow the advice on Go bags etc. are handy. If floods are a threat, you need to be ready to move.
  • Have good battery powered lighting. I own a Fenix E21 Flashlight and I kept it on me at all times during the power outage. I love this thing. The advantages of this light are: 1) it is super bright. I'm talking daylight in a dark room bright. 2) it is small 3) It is heavy duty and waterproof. I saw a youtube video where someone had it lit in a bucket of water for a day or something and it still worked. 4) It takes common AA batteries. Another suggestion is to get a book light for reading and a LED lantern for general lighting. A headlamp is also good for doing dishes or other work in the dark. Try to get them all running on common batteries so you can stock up on those (AA for example). Also have CANDLES. I hadn't had a candlelight (only) dinner in years and its amazing how much light a couple of candles can throw off. 
  • Have a good battery powered radio. When the power goes off, BOOM, instant loss of all those nice news anchors giving you up to the second updates on doppler radar so you will be dying to hear some kind of news and the radio is your friend in this situation. Seems like all of our clock radios took 9 volt batteries and at one point we ALMOST considered taking the battery out of the smoke detector to put in a radio for a few minutes but luckily we found one. Bonus points if it also has a hand crank as backup in case you're out of batteries. I can see these things selling like hotcakes in the wake of the storm. If you had solar powered stuff, it might have been ok for a very brief period of time, but there hasn't been much sun around lately.
  • Make friends. So you haven't spoken to your neighbor in three years? Well how do you feel now that he has a generator and you're in desperate need of someplace to plug an electric heater for an hour to keep frostbite at bay? I saw a lot of examples of people helping eachother out with some food, or even a place to stay. Your neighbors and family can be a huge help in times of emergency.
That's just a little advice from personal experience. There are more complete guides elsewhere ( for example) and I definitely recommend you check them out if a storm is headed your way.

Sunday, November 6, 2011

Smallcap Screen Part II - Lotus. Jiangbo and Huifeng

Ok, so maybe I should call this a microcap screen, but for now lets ignore the semantics.
I finally got around to checking into Lotus Pharmaceuticals. They use essentially the same corporate structure as Skystar, controlling a china-based entity through "contractual arrangements." They also executed a reverse split in 2010, yet the shares still trade for less than a dollar. I'm going to rule this one out as well. (If you want to know why, refer to my previous analysis.)

The final 2 similar-looking pharmas that show up on the list are Jiangbo Pharma and Huifeng Bio-Phar. I am going to save myself some work and assume that these companies also have a similar corporate structure as Skystar. To repeat: I'm not saying these are necessarily bad structures, I'm just saying they don't offer me enough certainty to invest my hard-earned money. You are free to make your own determination.

Saturday, October 29, 2011

Smallcap Stock Screen - Investment Ideas

Although I don't recommend most people invest in individual stocks, I do keep a (very) small portion of my investable funds in an account I actively manage. My results have been decent. I have a few stocks I track regularly and have been in and out of them a few times over the years. I've also done some experimenting with options (failure), shorting (great success), and various other securities. At the moment, I'm about 50% cash in the account and have kept my eyes open for potential ideas.

(Note: almost everything (except for a long term holding or 2) in this account and every company mentioned below falls into the category of speculation, not investment. An investment, upon thorough analysis, promises security safety of principal and a satisfactory return.)

Though I try to stay away from the smaller end of the spectrum due to the higher risk I associate with tiny companies, I figured I might run a screen on the small end of the market to see what popped up. To that end, I did a screen of microcap stocks with market caps below $20 million, P/Es below 12x, 5 year average ROEs above 15%, trailing 12 months EPS above zero, and 5 year revenue growth above 10%.

The result was a list of 24 stocks for further investigation.

One thing that immediately stood out to me on the list was the pharmaceuticals. There were four of them on the list with similar sounding names: Huifeng Bio-Pharm (HFGB), Jiangbo Pharma (JGBO), Lotus Pharma (LTUS), and Skystar Bio-Pharm (SKBI). They all had P/E ratios of 1.13 or below and also made me immediately skeptical.

Starting at the beginning, I pulled up a yahoo finance quote on Skystar. The stock trades for $2.15 per share and had a 52 week high/low of $1.39 and $10.58, respectively. All else equal, I'd rather buy a stock at its high than its low, so this was a positive sign. I did a quick calculation and if I bought this stock today at $2.15 a share, then sold it for $10.58, I would make a 392% return. (conversely, the people who bought it at $10.58 and sold it today are looking at an 80% loss).

I also noticed it traded only 580 shares last friday, or about $1,200 of total volume, showing that the stock is very illiquid. If I owned shares of this company and needed to sell for any reason, the lack of potential buyers in the market could mean I would have to take a discount on the prevailing market price to sell them. Though this is a risk, you can also see this as a positive. If a lot of people aren't buying the stock, chances are very few people follow the company and you might notice something others have missed. If the stock ends up being a true winner, people will eventually come around to realize the value of the company

I have no idea what the company does, so I decided to pull up its most recent 10-K. They might as well paint a bird on this thing and fly it above Busch Stadium because it looks like one giant red flag to me. The first page was enough to turn me off, and this rarely happens to me:

"We were incorporated in Nevada on September 24, 1998. We are a holding company that, through our wholly owned subsidiaries in China, Skystar Bio Technology Co.(Skystar Jingzhou) and variable interest entity (“VIE”), Xi’an Tianxing Bio-Pharmaceutical Co., Ltd. (“Xi’an Tianxing”), researches, develops, manufactures, and distributes veterinary health care and medical care products in the People’s Republic of China (“PRC”).

All of our operations are carried out by our subsidiaries in China and Xi’an Tianxing, which the Company controls through contractual arrangements between Xi’an Tianxing and Sida Biotechnology (Xi’an) Co., Ltd. (“Sida”), the wholly owned subsidiary of Fortunate Time International Limited, the wholly-owned subsidiary of Skystar Bio-Pharmaceutical (Cayman) Holdings Co., Ltd. (“Skystar Cayman”), which became our wholly owned subsidiary in 2005.

Such contractual arrangements are necessary to comply with PRC laws limiting foreign ownership of certain companies.

Through these contractual arrangements, we have the ability to substantially influence Xi’an Tianxing’s daily operations and financial affairs, appoint its senior executives, and approve all matters requiring shareholder approval. As a result of these contractual arrangements, which enable us to control Xi’an Tianxing, we are considered the primary beneficiary of Xi’an Tianxing.

On August 21, 2007, Xi’an Tianxing invested $68,550 (RMB 500,000) to establish Shanghai Siqiang Biotechnological Company Limited (‘Shanghai Siqiang’). Xi’an Tianxing is the 100% shareholder. Shanghai Siqiang serves as a research and development center for Xi’an Tianxing to engage in research, development, production and sales of feed additives and veterinary disease diagnosis equipments."

In addition to Xi’an Tianxing, Skystar Jingzhou also manufactures and distributes veterinary medicines including aquaculture medicines in China."

So Skystar is an Arizona-based holding company that set up a complicated ownership structure to comply with (ie, get around) Chinese restrictions on foreign ownership of companies. The company's main line of business is selling veterinary health care and medical care products in China.
As a general rule, anything involving a Special Purpose Vehicle (SPV) or a Variable Interest Entity (VIE) makes me nervous. VIEs, as Bloomberg puts it, are a "post-Enron version of Special Purpose Vehicles." The fact that Xi'an is a VIE means that Skystar stands to benefit the most from the company, but it does not own more than 50% of the company. Only being able to "substantially influence" rather than "completely control" the company's main subsidiary is a huge red flag for me.

The page also referenced a Cayman Islands based corporation used as part of the ownership scheme.

All of this shit might be on the up-and-up, but the number of huge risks on page 1 of the 10-k are enough to make my head spin, and I haven't even gotten into the specific kinds of products the company sells yet. There's the risk of being tiny, the risk of doing business in China, the risk of not controlling your main source of income, etc. etc. After doing a little further research on the internet, I came across a publication about "Investing and Operating in Restricted Industries in China" It looks like this type of ownership structure has been put in place a number of times and as far as I can tell, it looks like a way for Chinese firms to raise capital from American and other investors.

A few other great tidbits from the 10-k: The company leases a building in China that the chairman owns for about $24,000 a year. The company also had accounting issues: "On December 17, 2010, the Company filed an 8K with the SEC disclosing the termination of Frazer Frost, LLP (“Frazer Frost”) as our independent auditors effective as of December 13, 2010." They replaced their auditors. They identified material weaknesses in their accounting and internal audit functions and finally, they disclosed this:

"Conflicts of interests between the duties of our officers and directors who are also management members of Xi’an Tianxing to our company and  Xi’an Tianxing may arise. As our directors and/or executive officer (in the case of Mr. Lu), they have a duty of loyalty and care to us under U.S.and Cayman Islands law when there are any potential conflicts of interests between our company and Xi’an Tianxing. We cannot assure you, however, that when conflicts of interest arise, these individuals will act completely in our interests or that conflicts of interests will be resolved in our favor. In addition, they could violate their legal duties by diverting business opportunities from us to others. If we cannot resolve any conflicts of interest between us and them, we would have to rely on legal proceedings, which could result in the disruption of our business."

I work at least 11 hours a day, 5 days a week. There is no way I am risking my hard earned money on an equity ownership interest in a setup like this. Even if the China operation does make enough money to one day pay some back to shareholders in the US, who knows if they will ever even be able to get the funds out of China without the government intervening? I'm passing on this one. Though the stock quote might go higher in the next few years, to me the risk is not worth the potential reward.

One thing I definitely do give the company credit for being straightforward and disclosing risks in its filing.

I think I've had enough smallcap action for one day. I assume the other pharma companies on this list are similar to Skystar and plan to report back any findings when I get the chance to look into them. Hopefully this gives you a sense for the kinds of things I look for in an investment/speculation. There will be many other pitches to swing at, so I dont mind letting this one go by. In this case, the ownership structure was so risky in my opinion that it didn't even matter what the financials looked like.

Saturday, October 1, 2011

The most useful things I've ever purchased

Time and time again I've gotten household/automotive appliances (eg: george foreman grill or a $20 paper shredder) that have either broken or I've stopped using. Below are a few items I've gotten off of Amazon over the years that I have found to be well made and gotten a lot of use out of and I have no hesitation recommending.

1) Giant, Powerful Scissors.

Ok well maybe they refer to them as "Tin Snips" but these things are awesome, and amazingly useful. According to Amazon: "Super sharp blades easily cut through sheet metal, aluminum sliding and more ." I've used these to cut through so many things I can hardly keep count. In particular, they are good on packaging. The hard plastic packaging that most electronics seem to come in most days can be easily disposed of with this thing. It also eats right through whatever plastic ring in a package may be securing the item inside. Do yourself a favor and get the twelve inch ones. Whenever you need scissors on steroids, keep these handy.

2) Tire Inflator

I've had this Slime compressor for about a year and it is great. Throw it in your trunk and you will never have to pay a dollar at the gas station each time you want to inflate your tires. This particular model is pretty heavy duty and feels like it will last a long time. Plus, when you get that inevidable flat tire only to find out your spare needs 40 pounds of pressure, this thing will be there to help you out. It will also get you to the gas station if you discover a nail has slow-leaked your tire flat overnight. As a bonus, it also comes with attachments to inflate things like bicycle tires, basketballs and other inflatables.

3) Aeropress

If you need single serving coffee, forget about the tasteless pods that everybody seems to be buying these days. The Aeropress is the way to go. The reviews on Amazon speak for themselves. I've had mine for over three years now and it is the only thing I use to make coffee at home. This is especially good for people who (like me) enjoy strong coffee. Read all of the Amazon reviews if you don't believe me.
Being a finance person, I'm not a big fan of buying crap you don't need or can't use, but this stuff is either incredibly useful and built to last forever (the snips), saves you money and gives you peace of mind (the tire inflator), or saves you money and gives you delicious life-giving coffee (the AeroPress) and I'm willing to go out on a limb and recommend all of the items above. As long as you can comfortably afford them, you won't regret buying them.