Virgin Galactic thoughts

Apparently Virgin Galactic is going public, via a SPAC currently traded as (NYSE: IPOA). The SPAC is a Cayman Islands shell capitalized with US$708 million cash waiting to be invested by its control owner, Chamath Palihapitiya. Before the Virgin Galactic announcement IPOA was pretty much trading at salvage value (it has a designated 2 year lifespan to invest in anything before it had to be liquidated):

When reading the news, my initial reaction was that IPOA would jump to the roof, as the market itself (space tourism) is relatively untapped from a publicly traded perspective. I wanted to flip the stock like pancakes on a griddle. IPOA was going to receive 49% of the Virgin Galactic entity.

The powerpoint deck associated with the announcement is located here. Skip to page 55 – financial overview for the meat of what an investor would be buying into.

Somebody investing in IPOA is taking a blind leap of faith. Why would Virgin sell a huge stake in the business if it was actually going to generate the numbers claimed? The presentation talks about being EBITDA profitable in 2021, but the underlying reality is that if you can’t even get a low cost domestic flight company (with two leased Airbus 320s) going without injecting a ton of capital and a lot of pain, what makes one think that running a one-of-a-kind rocket ship is going to be any different? The other question is – who in their might mind will pay US$250,000 for a ticket to a 55-mile above planet earth trip and do it again? There doesn’t appear to be a lot of ‘repeat’ value in these types of trips unless if they can make them similar to SpaceX’s vision of a 1 hour trip to anywhere on earth (which, if reliable and repeatable, I could see a true market for – it won’t happen because of noise pollution). But it also brings up the question of operational risk – one crash and the business is shot for at least half a decade.

Whenever I get the compulsion to buy something based off of a news headline in the Drudge Report, I solve this by performing imaginary day-trading. I inevitably lose money in my mind, and that relieves the psychological burden of not being involved. Of course, it is more agonizing when you look at entities like Beyond Burger and ask yourself what you’re doing reading balance sheets and income statements.

One of my negative screens is that if I read about some company on the mainstream news and it is not portrayed in an excessively negative light, I tend to exclude it as an investment candidate. The less attention given to a specific company means there is likely to be more value to be had by a closer examination. Markets are strange in this respect. But with Virgin Galactic, I’ll be a happy spectator and wish them the best of success – what they do is cool, similar to SpaceX.

Genworth MIC potentially on the selling block

Genworth Financial (NYSE: GNW) owns 57% of Genworth MI (TSX: MIC). GNW has also been subject to a merger agreement with a China-state owned entity, China Oceanwide, which proposed acquiring GNW for US$5.43/share. One of the conditions is the approval of the various regulatory authorities. The key stumbling block appears to be the Canadian regulator, and as a result, GNW is proposing to explore selling the MIC entity.

There are two questions. One is who would purchase MIC, and the second is the valuation. Surely the acquirer would have to be a Canadian entity – my guess is that the CPPIB or provincial pension arms would be ripe candidates (which would ensure that substantially all of the Canadian mortgage insurance market is held by crown corporations). There are not a lot of insurers that would have the capacity to take on MIC – obvious candidates include MFC, SLF, GWO, FFH or IFC.

The market is up about 4% for MIC presently. There’s a pretty good case to be made that the transaction, if it were to occur, would have a fair value higher than the presently selling stock price, but I don’t see any potential acquirers over-reaching beyond CAD$50/share or so (which I think is the price that GNW will want to get). It just depends on how badly GNW wants this merger to complete – a purchase of GNW presently would gain 46% in value if the merger was completed – and they have huge issues of their own with respect to their long-term care insurance liabilities.

Canadian natural gas producers

I have taken a small equity position (roughly 2.5% each) in two Canadian natural gas producers. I’ve exhaustively looked at the (not obviously insolvent) producers that are at least 75% natural gas boe equivalent and chosen the two companies I’ve deemed ‘best’ in lieu of just making a home-brew index of all of them.

This is not a particular call on the natural gas industry in general – right now the economics are absolutely horrible for Canada. There have been some days where spot pricing has been such that you have to pay to give away your natural gas! The federal government is hell-bent on destroying the fossil fuel industry. The USA has shale gas coming out of their… well, you know. There’s no hope and only despair!

Sounds like a good time to invest.

However, run the thought experiment on every company you look at: “Let’s pretend you could acquire 100% of the company’s equity for ZERO, but had to take a personal guarantee on their outstanding debt. Would you take them over?”

Under the right conditions, a lot of these companies will double, triple or even quadruple their equity prices. The timing is unclear, but we will see. I remember getting into oil and gas for a short-lived foray in 2014 that exhibited a colossal amount of stupidity, but will this time be different?

Canadian preferred shares – commentary

Early 2016 was a good time to invest in Canadian preferred shares, and there was also a lot of carnage in the equity market at the time. Five-year government bond yields bottomed at 0.48% in February 2016, and you can see the damage it did to the preferred share market – ZPR is an ETF that tracks 5-year rate resets:

What is interesting is a well-timed entry on the bottom (not completely clairvoyant, but say $7.50/unit) and an exit anytime between October 2017 to 2018 would have netted a total return that exceeded the TSX with less risk. Of course, you can’t determine those preferred shares will do better than the TSX when you’re sitting at your computer console in February 2016!

Today’s investing environment has plenty of parallels – the 5-year interest rate has dropped to 135bps from 240bps back in October. If 5-year yields continue to drop further, there is a high degree of likelihood that preferred shares will also be sold down to levels seen in 2016.

The question is getting the timing correct.

A lot of retail investors get burnt by buying into a relatively high yield product thinking it is safe. While the yield itself may be safe (it has been awhile since I can recall a dividend suspension in the Canadian preferred share marketplace beyond Aimia and some really garbage split-share corps), the capital is most certainly at risk. It looks like a very easy leveraged trade on paper when margin rates are 2.5% and you see a financial instrument at 5%, but how much pain can you take when the yield goes to 6%? 7%? You’ve just lost nearly 17% and 29% of your capital, respectively.

Using a real example, investors in Brookfield Preferred Shares series 30 (TSX: BAM.PR.Z) back in September was trading at par, had a near-guarantee 4.7% yield, and a rate reset of 2.96% over the 5-year government bond rate. Some enterprising chap sees margin rates at 2.5% and decides to invest $50,000 cash to buy $100,000 of BAM.PR.Z. Now they’re sitting on $23,000 in equity plus $3,500 in accumulated dividends and they would have surely received a margin call (or would be very close to one). How much of the population out there is leveraged to preferred shares in this manner and are feeling nervous? How many will hit the sell button to take the tax hit and move away from this “guaranteed leveraged return”?

Ideally when they all want to cash out, that’s the time to get in. Doesn’t quite feel time yet.