GFL Financial Scandal – or what to do if a short selling firm reports on one of your holdings

Thanks to Etienne and another that was kind enough to email me, Spruce Point Capital wrote a hit piece against GFL Environmental (TSX: GFL / NYSE: GFL, GFLU).

The allegations can be summarized as shady people, shady accounting, shady history, shady operations and shady associations. Apparently being associated with the late Toronto Mayor Rob Ford (infamous for being busted in his term in office for doing cocaine) is also is grounds for financial excommunication.

Do I believe the report? Not in its entirety. Do I dismiss the report? Not in its entirety.

The investment thesis for GFL has always been on whether they possess an ability to process acquisitions and make them more profitable. Even at the IPO their financials were a train wreck to go through, although you could see how it could be done to yield a decent amount of free cash flow, in line with major competitors (Waste Management / Waste Connections / Republic / etc.).

The report does present evidence that there have been exaggerations/creative interpretation by management, in addition to many acquisitions in the past that appeared to deliver sub-par results that were disappeared 1984-style.

One of the great things about being a small-time investor is that you can get in and out of positions (in most cases) by clicking a button. Shortly after the peak of the Covid crisis, I took a minuscule position in GFLU which I offloaded today.

Just imagine if you were an institution and have 50 million shares of this thing and the 180 day lock-up expiry doesn’t happen until August 31. Or if you were one of the purchasers of the US$750 secured bond financing, getting a paltry 3.75% for 5 years on an investment that doesn’t seem so secure anymore. Egg on your face as an institutional manager!

It actually doesn’t matter for me whether this report is true or not, simply because the thesis of any future investment in this company has changed. It is now a thesis on whether the evidence laid out in this report or not is factual enough to sink confidence in the company enough that it won’t be able to raise further financing. On balance, I deeply suspect it will survive and just like a lot of these short seller reports, they turn the most tenuous of connections into big news, just like a political “guilt by association” hit piece.

However, to deal with this in the future takes mental space that I can ill afford with a portfolio that is spread out with more individual holdings than I have ever had in my financial history. This quarterly cycle of 10-Qs and conference call transcripts just slammed me. I just do not have the mental capacity to follow the inevitable gyrations that will be occurring as institutional holders try to confirm or refute the GFL allegations in the upcoming weeks and months. Too many eyeballs are going to be looking at this, and my eyeballs aren’t going to have a competitive advantage of any worthy note. So I’m out, taken it off my watchlists, and focusing elsewhere.

This is also why I don’t get involved in any other financial scandal stocks (e.g. Herbalife), although I must say the Home Capital Group (TSX: HCG) fiasco in 2017 was most fascinating. There’s just too much attention and too many people, some a lot smarter and most of them better resourced than I, looking at these situations.

There is a valuation claim that I was suspecting from the very beginning that if GFL does have their crap together that they can head up to the CAD$50 range, but clearly that’s now going to turn into a “show me” with regards to their mammoth acquisitions they have recently made. This will take a lot of time (at least 18 months), and once the IPO lock-up period expires, there’s going to be a lot of gyration in the shareholder base. One tailwind for the company will be the inevitable inclusion in the TSX indexes (with a decent shot to get into the TSX 60 if it appreciates from here on in) which will cause its own momentum. We will see, and for those that are sticking around, I wish them the best of luck.

California Power Grid

Wow, that was quick.

I said less than two weeks ago:

One major event that will occur in the future (a matter of when, not if) will be a significant power grid failure that will have been instigated by having too much intermittent energy sources on the grid, without available backup from domestic or external grid sources. This may be caused by a freak transmission failure (cutting an intermittent-heavy grid from a dispatch-able heavy grid) or some other ‘black swan’ event. When this occurs, there will likely be a dramatic shift in power generation policy to increase the robustness of a domestic power grid.

And what did we get last Saturday? Headlines such as:

(August 14, 2020) * Stage 3 Emergency Declared; rotating power outages have been initiated to maintain grid stability
(August 15, 2020) ISO Requested Power Outages following Stage 3 Emergency Declaration; System Now Being Restored
(August 16, 2020) Flex Alert Issued for Next Four Days, Calling for Statewide Conservation

What happened?

Excuse my crappy handwriting, but I had to illustrate this. Factors:

1. Wind dies down (can’t predict the wind very well, so you have no idea what your future supply is going to be);
2. Solar gets interrupted during the peak of the afternoon due to clouds;
3. Natural gas supply is down due to plant shutdown;
4. Cannot import (other grids are facing similar demand/supply issues).
5. Record-high daytime temperatures (e.g. Riverside, CA which is a suburb about 80km east of Los Angeles, at daytime highs of 40 degrees C), which causes huge demand for air conditioning.

What do you get? Rotating blackouts.

While I wouldn’t call this a “major event”, the fact that a major jurisdiction can’t keep the lights on speaks volumes.

This issue isn’t solved by adding renewables onto the grid – indeed, having too many renewables on the grid with the lack of dispatchable power sources was the cause of the problem.

If my suspicion is correct, this is going to be the start of a paradigm shift on what was a dead power production market (ruined by floods of cheap capital for intermittent power sources). I can’t tell whether this comes in the form of further power price increases (see: California, Ontario, Germany, etc.), increases in dispatchable energy supply (read: natural gas, nuclear or thermal coal!), or energy restriction mandates (or a combination of all), but either way, there are obvious investment angles coming down the line.

My only other comment is there are operational implications when you allow your quasi “crown corporation” primary power supplier PG&E (NYSE: PCG) to be sued into bankruptcy due to wildfire transmission line risk – when you get into situations like this weekend, it is obvious they will be shutting down transmission grids which reduces the robustness of a power grid since they don’t want to get sued to death again in case a spark catches fire somewhere. I wonder when they will get sued for constructive negligence because they shut down transmission lines and caused a huge cascade power failure which caused even more economic damage. Companies that operate under heavy regulatory coverage in California live and die at the behest of the state – watch out if you’ve got capital in PCG equity!

Input Capital – Really suspicious

Input Capital (TSXV: INP) announced they were going to be bought out by a company (Bridgeway, trading as BDGY) for $1.75 in cash.

This represented nearly a double in share price and a total purchase price of nearly $100 million dollars.

The only problem is that when I am doing research on Bridgeway, I am getting the shell of an entity with a market cap of about $600,000 (yes, six-hundred thousand dollars).

I dig into the SEC filings. They are late on their 10-K and 10-Q filings. Their last snapshot comes from their S-1 (registration statement) where on page 47 we see a financial statement, as of September 2019, that contains nowhere close to $100 million in cash. Indeed, it is about $1.7 million in cash and a whole bunch of liabilities (about $40 million).

There are no 8-K filings indicating they are in the receipt of any further financing except for about $750k (not million) they raised in March 2020.

I couldn’t find shares to borrow, hence this post. While I don’t give investing advice, I think my conclusion from this post is quite obvious.

Ag Growth International – Q2-2020 – steady as she goes

My thesis in Ag Growth International (TSX: AFN) was written in a very condensed form back in “we are all going to die of COVID” April, which seems like an eternity ago.

After reviewing AFN’s quarterly report, business is even better than I was thinking post-COVID. The stock price is now a closer reflection to where it will be going, i.e. still higher.

In fact, if I didn’t already have as high a position in this stock as I did (I took a fairly large position in early April and that has ballooned due to appreciation), I would be buying more.

Nearly nobody in retail-land follows this stock – the lack of commentary on places like Seeking Alpha or Stockhouse is comforting. I don’t see people on Robinhood flipping this stock around. Even after reporting what is unarguably a good quarterly report, the stock only traded a shade under 200k shares.

There are some related companies with somewhat less in the way of competitive advantages that are trading relatively cheaply as well, but business-wise AFN is in the sweet spot. I managed to get shares of one of these other related companies, but it was a ridiculously small position before their stock took off as well.

Transforce is run by a genius

Alain Bédard is very good in capital allocation. TFI International (TSX: TFII) announced they are going to sell 4 million shares to the market.

Their stock chart looks like this:

When you have a stock chart like this, what do you do? Raise equity capital while the going is good. Especially after you’ve exercised and dumped a bunch of stock options (he still owns about 4.1 million shares at present, so still plenty of skin in the game).

I took a small shot at them last February for selling equity after buying back shares, but this move I think is admirable – will also get their debt down to something a little more comfortable. They’ve acquired a couple companies since the Covid-19 debacle began.