Portfolio Positioning and Outlook

The portfolio entered 2015 with adjusted exposure of about 59% net long broken down as follows:

table_4

Net exposure is a bit above the fund’s long-term average of 50%; we’re finding a reasonable mix of long and short ideas. Mostly dampened volatility continues to favor puts as the most efficient way to express negative opinions. We’ve always preferred to express highly uncertain, binary, volatile, or small cap short ideas as puts, and that will remain the case most of the time. Long-term puts (LEAPs) are also quite interesting when available, since they’re one of the few ways to hedge tax efficiently. Higher volatility would make conventional shorting more attractive as a means of hedging if borrowing fees are reasonable.

In general, we’ll tend to get longer during oversold markets and shorter during overbought markets. When we have lots of good long investment ideas, we like to be close to 100% gross long. We’ll then hedge a portion of the long exposure on an opportunistic basis depending on the number, nature and attractiveness of short ideas as well as how they may correlate to the long positions. The average upside to our fair value targets in the long book was about 40%, similar to the beginning of the year. General appreciation during the year eroded some or all of the upside in certain positions but we were able to find new ideas to replace them. The non-energy-linked portion of the short and put books remains very attractive while the energy hedges are playing out quickly. Key themes in the short/put books are: Credit Exposed Equities, Imperiled Gold Mines, Bloated Restaurants, The Crowded Cloud and Unproven Technologies.

Leverage

We are currently using little to no margin debt in the Partnership and employed little to none during 2014. We’re generally seeking investments where expected returns are sufficiently attractive without the use of debt capital, though we are open to conservatively employing modest leverage in times of extreme opportunity or when the cost of borrowing can be locked in at an extraordinarily cheap price over a time horizon matching that of the investment to which it’s tied. The investments in our current long book on average have very modest levels of leverage on their own books, although there are a few highly leveraged (and typically out-of-favor/distressed) situations where we feel a company’s outlook is improving and debt is being reduced in a manner that can be quite beneficial to equity holders. On the flip side, a segment of our short book is frequently dedicated to companies with leveraged balance sheets in combination with other looming problems.


The above article has been excerpted from the Crawford Capital Partners, LP 2014 Annual Review.
This document does not constitute any offer to issue or sell, or any solicitation of any offer to subscribe or purchase an interest in Crawford Capital Partners, LP. A private placement must precede any offering of interest. This document is confidential and intended solely for investors and their agents. Any use, distribution, republication, forwarding or copying without the express written permission of Crawford Fund Management, LLC is strictly prohibited.


The content of this website is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this website. BeyondProxy’s officers, directors, employees, principals and/or contributing authors may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated on this website. This summary is meant in no way to limit or otherwise circumscribe the full scope and effect of the complete Terms of Use.

The Tunneling of Corporate Wealth in Asia

The following article is extracted from the Bamboo Innovator Insight weekly column about the process of generating investment ideas among wide-moat businesses in Asia. Each month, an in-depth presentation on one such business is featured in The Moat Report Asia.

During the 1990s in the city of Yichang, Hubei province, central China, you are considered a god if you are a “Monkey King” – if you work at the Monkey King Group (MKG) (宜昌猴王焊丝有限公司). MKG was a Shenzhen-listed industrial powerhouse as one of China’s 512 key SOEs (state-owned enterprises) and formerly China’s #1 maker of welding materials. Around 14 years ago, at the end of 2000, the parent company of MKG was placed in liquidation.

The MKG case reminded us about the technical default saga of Shenzhen developer Kaisa Group Holdings (1638 HK). Bondholders and investors in earlier cases were burnt – investors in Suntech, Ocean Grand Holdings, Celestial Nutrifoods and China Milk Products Group got 5% or less, while investors in Asia Aluminum Holdings, which collapsed in March 2009 with $17.7bn of debt, received about 7%. Sino-Forest debtholders recovered 17%

Like Kaisa and many of the Asian companies, MKG had guaranteed the loan of its parent company who had used the money to speculate in the stock market. In Dec 2000, MKG started an accounting “tunneling” exercise that shrunk group assets from RMB2.42bn to RMB371m, according to its biggest creditor Huarong Asset Management who bought RMB622m in MKG debt.

Loan guarantees presents a seemingly innocuous Opportunity to maliciously tunnel out corporate wealth in Asian companies.

Take the case of Olympus. It deposited ¥21bn in Japanese government bonds with LGT Bank and arranged for the bank to use these bonds as collateral for a loan to two shell companies, the “tobashi”. The unconsolidated shells in turn used the borrowed funds to buy the toxic investments from Olympus at the original cost. Olympus recorded the amount it deposited with LGT and the toxic assets were considered “sold” to the shells, thereby avoiding recognizing losses on these underwater securities. In other words, Olympus acted as a guarantor of loans made by the banks to the shells by depositing funds at the banks equal to the amount loaned (figure on left).

Untitled

(L): Olympus accounting: DR Government Bonds ¥21bn, CR Cash ¥21bn; DR Cash ¥21bn (from the shells), CR Toxic Financial Assets ¥21bn (“sold” to shells); (R): Photo of MKG plant

Hence, cash in the balance sheet in Asian companies is invariably never really cash unless one examines these related-party transactions (RPTs), often held in scant regard by investors using western-style financial statement analysis and Asian auditors. Even in Singapore, the Qualification Programme (SQP), a post-university professional accountancy qualification, does not cover at all the auditing of RPTs which is all-important in the Asian capital jungle.

The Monkey King is just one of the many brief cases that we will be sharing in Week 4 of the Accounting Fraud in Asia course in SMU. Last week, we have discussed about the Incentivized Asian “Wedge” Snake with indirect measurements of accounting tunneling using the complex and opaque corporate structures set up by the controlling owners. This week, we are making the breakthrough to explore the Shedding of the Asian Snake’s Skin: The Opportunistic Tunneling of Corporate Wealth with the direct measurements of accounting tunneling.

This Week #4 is a breakthrough in the sense that we are exploring new frontiers that have not been discussed even in top-tier accounting and finance research journals since the Asian Snake has adapted itself to escape the various measurements devised by researchers. Take loan guarantee which has shifted to intercorporate loans, classified under “Other Receivables”. With some reforms mitigating these RPTs, the Asian Snake has adapted and shifted to other accounts in disguised forms. Hence our earlier article for a sense of urgency to develop a new composite measurement of tunneling.

We are pleased to present the course presentation materials exclusively for our Moat Report Asia subscribers:

Week 1 – Survival in the Asian Capital Jungle: Who Knows What When? (108 slides)

Week 2 – Western Tools to Catch An Asian Snake? (111 slides)

Week 3 – The Incentivized Asian “Wedge” Snake to Tunnel Corporate Wealth (86 slides)

Week 4 – Shedding of the Asian Snake’s Skin, The Opportunistic Tunneling of Corporate Wealth (157 slides)

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Download the presentation slides.

We like to invite You to participate in our Asian Extractor website, which we hope will develop into a thought leadership platform on accounting fraud in Asia with analyses and opinions from the students and expert guest speakers in the course as well as from global experts.


Learn more about The Moat Report Asia.

Contrarian Themes: Crowd in the Cloud

Cloud based computing has attracted an excess of capital, entrants and enthusiasm, setting the stage for a wave of failures.

Consensus View (2015)

Cloud computing is a compelling and proven model for efficiently allocating IT capital, bandwidth and resources among users, obviating the need to own and manage expensive, complex systems in house. The trend of converting in-­‐house IT to cloud-­‐ based IT is in its early stages and the future is very promising for hundreds of cloud computing providers across many industry verticals. Large investments now by providers will pay off handsomely in the future.

Alternative View (2015)

We agree strongly with the advantages of this new business model, but in practice observe many upstart cloud computing ventures struggling to gain scale. The typical venture adopts a vertical niche, weaves cloud into the business plan and then raises capital to finance up-­‐front construction of its platform. Then comes the hard work of finding enough customers willing to pay recurring subscription fees to scale to profitability. Most of these ventures are signing up small and mid-­‐sized customers while pursing the elusive Holy Grail—the large enterprise customer. It’s a race against cash burn, investor patience, willingness of employees to work for paper stock options and VC’s eager to liquidate their holdings while the market is enthused. This will prove to be an industry where a few scale players and the very best niche solutions will survive. Most of the rest will be forgotten road kill, and a few lucky ones will get bought for more than they are worth. Many current public companies will vanish with hardly a trace.

Update/Resolution

Stay tuned.


The above article has been excerpted from the Crawford Capital Partners, LP 2014 Annual Review.
This document does not constitute any offer to issue or sell, or any solicitation of any offer to subscribe or purchase an interest in Crawford Capital Partners, LP. A private placement must precede any offering of interest. This document is confidential and intended solely for investors and their agents. Any use, distribution, republication, forwarding or copying without the express written permission of Crawford Fund Management, LLC is strictly prohibited.


The content of this website is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this website. BeyondProxy’s officers, directors, employees, principals and/or contributing authors may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated on this website. This summary is meant in no way to limit or otherwise circumscribe the full scope and effect of the complete Terms of Use.

Contrarian Themes: Gold Shakeout

Gold ceases to be a favored asset and the gold mining industry suffers a major shakeout.

(capital committed 2009-­2012)

Consensus View (circa 2009)

Gold bullion price will continue its decade‐long bull market upward since it protects against debasing paper currencies and acts as a safe haven during turbulent times and doomsday scenarios. Furthermore, gold miners represent an upside leveraged way to invest in gold.

Alternative View (circa 2009)

As businesses, gold miners (particularly junior miners) are risky, cash-­‐hemorrhaging operations. The gold may not be found, may not be possible to lift profitably, may be hard/costly to remove from the country where it’s found, and the promoters of the companies may lie to investors. Additionally, gold itself is not intrinsically useful other than for jewelry and a few minor industrial applications. It has no yield and must be stored/guarded. Historically, it’s prone to falling out of favor quickly and may do so again, which would be a dagger in the hearts of the junior mining companies.

Update/Resolution (2014)

Following 12 up years, the gold bullion price dropped sharply last year and was little changed this year. Gold may be in the early stages of losing its favor as an asset class as macro forces normalize toward higher interest rates and a stronger dollar. Gold bugs now feel the performance drag and are starting to wonder whether it’s better to own a shiny piece of metal versus a business that grows or can pay dividends. The stress on gold mining operations has increased dramatically and the shakeout we’ve been anticipating is starting to occur. We received a modest performance contribution this year from our put basket (particularly from Allied Nevada and Barrick), but the meltdown has occurred in such a slow moving fashion that we’ve not yet gotten the big reward for our analysis. We continue to maintain the posture—perhaps we’ll see the stress culminate in a downward inflection in 2015.


The above article has been excerpted from the Crawford Capital Partners, LP 2014 Annual Review.

This document does not constitute any offer to issue or sell, or any solicitation of any offer to subscribe or purchase an interest in Crawford Capital Partners, LP. A private placement must precede any offering of interest. This document is confidential and intended solely for investors and their agents. Any use, distribution, republication, forwarding or copying without the express written permission of Crawford Fund Management, LLC is strictly prohibited.


The content of this website is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this website. BeyondProxy’s officers, directors, employees, principals and/or contributing authors may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated on this website. This summary is meant in no way to limit or otherwise circumscribe the full scope and effect of the complete Terms of Use.

Contrarian Themes: MLP Meets Charles Ponzi

Some publicly­ traded MLPs may not be the stable income sources they are believed to be.

(capital committed 2011)

Consensus View (circa 2011)

In a yield-­starved world, Master Limited Partnerships (MLP) offer investors a solid income stream backed by hard essential infrastructure assets (like pipelines) and convey the tax advantages of a partnership.

Alternative View (circa 2011)

All bubbles start with the germ of a good idea. Companies from diverse areas (e.g. shipping, refineries, frack sand, graveyards) are rushing to become MLPs since they typically get a higher valuation than their non-­MLP peers and are liked for their tax-deferral advantages. The core problem is that many of these ventures don’t generate free cash flow and are dependent upon the equity and credit markets to pay their dividends. The companies claim they are simply reinvesting in growth, but it will be interesting to see what happens if/when the capital markets run out of appetite to keep funding them, and the dividends actually have to be paid from funds generated by operations after maintenance capital spending. As long as the dividends are flowing, the investor dialog about these entities is sorely lacking in scrutiny. Eventually, some MLPs may come to be viewed more as Ponzi-­like.

Update/Resolution (2014)

MLPs as a group have now underperformed for two years and sporadic signs of serious stress have emerged. Last year’s warning sign was the falloff in distribution growth among the weaker players. This year, several MLPs were forced to cut their distributions; the unit prices were instantly and severely punished in the market. The sudden large drop in commodity prices starting in October has exposed weakness even further. Some management teams prudently contemplated lower energy prices, but plenty have not hedged effectively and it’s now very expensive or impossible to do so after the fact. We continue to hold a basket of puts on the MLPs that appear riskiest to us. We harvested one that fell 80% but added to others where downside risk remains. Implied volatility was so low that downside exposure was very cheap in this sector up until October, but now insurance costs are rising as risks become more evident. Not all MLPs are poorly run, but a number of lower quality ones are capitalizing on the popularity of the asset class and investor complacency to perpetuate their enterprises. If interest rates ever normalize upward, it would be a major blow to this group—higher borrowing costs and a higher hurdle rate. Barron’s recently ran an updated version of an excellent study of the life expectancy of cash burning internet/tech companies from 1999 that concluded things were not as bad today as during the internet bubble. If the article had studied the E&P and MLP sectors, it would have looked at lot more like their 1999 article.


The above article has been excerpted from the Crawford Capital Partners, LP 2014 Annual Review.
This document does not constitute any offer to issue or sell, or any solicitation of any offer to subscribe or purchase an interest in Crawford Capital Partners, LP. A private placement must precede any offering of interest. This document is confidential and intended solely for investors and their agents. Any use, distribution, republication, forwarding or copying without the express written permission of Crawford Fund Management, LLC is strictly prohibited.


The content of this website is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this website. BeyondProxy’s officers, directors, employees, principals and/or contributing authors may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated on this website. This summary is meant in no way to limit or otherwise circumscribe the full scope and effect of the complete Terms of Use.