Wednesday, December 19, 2012

Betting on a Natural Gas Rebound

I'll start off by saying I'm not an oil & gas industry expert, probably just the opposite, so the majority of this post will be qualitative in nature, but I think any investor with a long term outlook could agree that natural gas prices must come up over time.  New fracking and horizontal drilling technologies have made previously unattainable resources accessable creating a booming supply of domestic natural gas in the United States.  The 2011-2012 mild winter didn't help the situation, it was the 4th warmest on record.  Since one of the primary uses for natural gas is heating homes in the winter, supplies remained elevated and prices dropped to below $2 per bcfe as the winter ended. 

Natural gas prices have rebounded to $3.34 per bcfe, but very few natural gas producers can turn a profit at these prices, and those that can are limiting their new investments in additional resources.  The old saying is the cure for low prices, is low prices, it causes producers to stop or slow production, and it encourages new sources of demand.  Low natural gas has increased demand in three main ways:
  • Electricity utilities are switching from aging coal plants to gas as its become cheaper, cleaner, more politically agreeable
  • Encouraging discussion and investment in exporting liquified natural gas to exploit the large spread between natural gas prices in the US and elsewhere in the world 
  • Spurring on the natural gas as a transportation fuel trend, especially for commercial vehicles
On the supply side, producers have reduced the rig count by 50% compared to last year, it's a bit of a leading indicator so it's yet to show up in natural gas supplies.

These are two good data points to keep bookmarked to keep updated on the supply side:
Last winter/spring (in hindsight too early) I started searching for a way to go long natural gas, I passed on the poorly put together yet surprisingly popular natural gas ETF UNG and stumbled on Ultra Petroleum based out of Texas.  Despite the name, Ultra is almost exclusively a producer of natural gas, and pretty much the lowest cost producer.  They operate in two main areas, the Pinedale and Jonah fields in Wyoming and then in the Marcellus Shale region of Pennsylvania (through JV partners in the Marcellus).  Below are two slides that Ultra provides on a regular basis showing their cost structure compared to peers and their breakeven points for net income and cashflow, clearly they have structured their operations in such as way where they can survive in a low price environment and thrive in a more normalized one.


The major concern with any smaller independent explorer is the balance sheet and their ability to meet the high capital expenditure costs.  Ultra has been proactive about improving the liquidity position as evidenced by their recent sale of mid-stream assets for $225 million.  In 2012, Ultra will spend a net $600 million on capex compared to $1.5 billion in 2011, while only modestly increasing debt.  Its clear if you listen to recent conference calls that management is not willing to spend more money than necessary in this environment and is more focused on long term profitability over short term growth in assets, just the type of management I like.

In summary, Ultra Petroleum is a great way to invest in the eventual rise in natural gas prices.  It does experience a lot of daily volatility, so have a strong stomach before jumping in and be prepared to hold it through the cycle, although it seems reasonable to assume we've seen the low in natural gas prices.

Thursday, December 13, 2012

Asta Funding

As Bruce Berkowitz of Fairholme Funds puts it, "investing is all about what you give versus what you get."  One way to go about looking for value is determining when GAAP accounting rules often result in a company's assets being carried at values far less than their intrinsic value. 

Asta Funding is such a company, their main business is as debt collector on defaulted loans, not exactly a popular or sexy business model.  Asta acquires portfolios of consumer receivables for pennies on the dollar and then it goes about the collection process to recover as much of the original loan as possible.  The collection of these receivables has typically been attempted by the originator and potentially several others, these are really aged and bad debts. 

Asta Funding is a family run business by the Stern family, who control 30% of the shares outstanding.  The company's founder is Arthur Stern, who at 90 is still a company director and "Chairman Emeritus".  His son, Gary Stern, is now the President and CEO and has been in the post for close to two decades.

Asta has $106,347,000 of cash and marketable securities as of 9/30/12, with virtually zero recourse debt, versus a market capitalization of $121 million.  A little history, in March 2007, Asta made a mistake in buying an incredibly large receivables portfolio at the top of the market, called the Great Seneca portfolio, a $6.9 billion portfolio for $300 million, by far the largest acquisition they had ever done.  They paid for the portfolio with $225 million in non-recourse loans and $75 million from their credit line.  The portfolio has been significantly written down and currently sits on the books for $65.4 million versus $61.5 million in non-recourse debt.  The company's business plan is in a bit uncertain going forward as they are not making any large receivable purchases since they believe the price is too high, a market condition also mentioned by other publicly traded competitors.

The potential value in Asta comes from how they account for their consumer receivables portfolios.  When the company can no longer determine the timing of cash flows from one of their portfolios, they switch from the interest method to the cost recovery method of accounting.  Under the cost recovery method, all cash flows from the portfolio go immediately towards a reduction in the principal amount of the portfolio.  Compare this to the interest method, where a portion of the cash flows is recorded as revenue and a portion as principal reductions.  Eventually, the entire portfolio is written off under the cost recovery method even if there are still cash flowing assets remaining in the portfolio.

The cost recovery method understates the true value of the consumer receivables as it reduces revenues in the near term as the company recognizes basically no revenue until the entire portfolio has been recovered, defers taxes as a result, and then eventually creates a "zero basis" asset that has no book value but produces cash flows.

Asta experiences considerable revenue from these zero basis portfolios, $36.4 million for the fiscal year ended 9/30/2012.  The revenue received on the zero basis portfolios is surprisingly consistent, clearly showing these assets have considerable value that is not being portrayed on the company's balance sheet.  Calculating the value of the zero basis portfolios is difficult, as the company does not provide much information in any of their filings.  In order to ballpark the amount, I took an quarterly average of the revenue for the last two years, ran that revenue off at 5% per quarter for 3 years (0 revenue after 3 years), took out 40.3% for taxes, and then discounted those cash flows back at a 16% discount rate to be extra conservative.  That comes out to an NPV of $37.4 million that is being carried at zero.

Since the Great Seneca portfolio's debt is non-recourse, let's just assume that the portfolio eventually ends up being put back to BMO, the lender.  Shedding this portfolio on both the asset and liability sides would result in an overall $3,937,000 write-down.  The net effect of these two adjustments (adding the zero basis assets and removing Great Seneca) adds additional $33.4 million to the assets making Asta's current market price look even cheaper when compared to book value.

What is the company doing to close the gap between the market value and instrinist value?  Asta has been repurchasing shares, $16 million worth in the last year most of which came in one block trade with Peters MacGregor Capital Management ($9.4 million, 1 million shares).  Expect Asta to pursue similar private market transactions as the limited trading volume of their stock limits their ability to repurchase shares in the open market legally.  They also announced a fairly insignificant special dividend of $0.08 today, speeding up the 2013 dividend ahead of what is anticipated to be higher taxes on dividends next year.

Additionally, Asta has also started investing in two related businesses, personal injury settlement financing and divorce funding financing:
Management is potentially reaching outside of their circle of competence in these recent new businesses, however both have joint venture partners who are doing the day-to-day managing and high hurdle rates before those partners receive additional returns, the incentives should be aligned for both to be profitable.  Currently they're only a small piece of Asta, accounting for $18.6 million (listed as other investments), or 8% of assets, but these could be potential growth areas if the traditional consumer receivable portfolio business continues to be uneconomic.

Asta Funding isn't an outstanding operator or a franchise company, but it's clearly cheap and the cash position provides a large margin of safety.

Disclosure: I own shares of ASFI

Tuesday, December 11, 2012

Eagle - Unforced Error

I committed the dreaded "unforced error" with the Eagle Hospitality preferreds as the company announced this morning that it had failed in its attempt to sell the 13 hotel properties and had handed over the keys to the Blackstone.

Eagle Hospitality's Secured Lender Takes Ownership of 13 Hotels
Blackstone Adds to Hotel Haul with Eagle Foreclosure

In the press release Eagle states that they will use the remaining funds to wind down the operations and no distributions will be made to the preferred share holders.  Luckily this was only a small and speculative position for me, and with shares trading down 99% this morning I will likely hold my position (may need to sell for tax reasons) to see if any of the large shareholders make a stink about the outcome or there's more disclosure around what assets the company has remaining.  Lesson learned.

Thursday, December 6, 2012

Quick Gramercy Update

Gramercy recently announced the closing of their two previously discussed transactions, one the Indianapolis industrial properties last week and the much larger Bank of America portfolio transaction today.

Gramercy Capital Corp. Announces the Acquisition of a $27.125 Million Industrial Portfolio

Gramercy Capital Corp. Closes the Previously Announced Acquisition of a $485 Million Portfolio in a Joint Venture with Garrison Investment Group

Both transactions closed at nearly the same terms as previously described, which speaks well for management transparency and their ability to meet expectations.  The industrial properties were purchased for cash, but management has discussed the advantage of being able to close with cash quickly and then refinancing once the dust settles, so expect to see a mortgage put on the properties shortly.

However, the closing of these properties doesn't change my valuation of the common shares as Gramercy still needs to increase assets, and thus the equity, to spread their overhead costs across a larger base.  One news item I'm looking forward to is the sale of the CDO equity and management business (hopefully before year end), if the sale brings in a material amount it would improve the outlook by freeing up additional cash for investment without issuing shares and clear most of the complexity in the balance sheet.