KCG Holdings – Significant share buyback

KCG Holdings (NYSE: KCG) I’ve identified as a fairly good risk-reward candidate last month.

Yesterday they announced they came to an agreement with one of their major shareholders (whom were part of the recapitalization/reverse takeover of the predecessor firm after their major trading glitch on August 1, 2012) and have swapped 8.9 million shares of BATS for 18.7 million shares of KCG stock and 8.1 million at-the-money (roughly) warrants.

After this transaction, KCG still has 2.3 million shares of BATS – they did liquidate about 2 million shares on the open market over the past month.

This transaction has a positive double-whammy for book value – not only are the BATS shares accounted for at less than market value (which means the transaction will cause an accounting gain), but the KCG shares are being bought back for well under book value. Even when accounting for the not insignificant tax bill that will result (about a hundred million!), the final book value of KCG would be around $18.79/share after the transactions.

KCG will have about 67.5 million shares outstanding and 5.1 million warrants outstanding (strike prices of $11.70, $13.16, and $14.63, with each about 1/3rds of the warrants). These are likely to be exercised and shares sold in time – each of these warrants expire in July 2017, 2018 and 2019, respectively.

The corporation is trading slightly more than 20% underneath tangible book value. They have historically made money, especially in volatile conditions. The word “volatile” is also used to describe the new President-Elect. Needless to say, this has potential.

The other note is that CEO Daniel Coleman owns 1,487,907 common shares, or about 2.2% of the company, which is not a trivial amount of capital. He also owns 161,132 warrants, and 1.7 million stock options at a strike price of $11.65/share (making the effective ownership about 4.8% assuming the exercise of warrants and options), plus stock appreciation awards at $22.50/share, due to expire in July 2018. There is some serious incentive for him to get the stock price higher.

Pengrowth Debentures – To be redeemed

(Update, December 21, 2016: The proposal was shelved because PGF’s senior debt holders did not want cash to go to junior creditors.)

A short couple months ago I wrote an article about a “very likely 12% annualized gain” in the form of buying (TSX: PGF.DB.B) at 97 cents.

So it looks like I gave up that return (at least with some idle cash holdings, I do have a position from far cheaper prices earlier this year) as management announced today they are seeking consent from debtholders to allow the company to redeem them as if they have matured on March 30, 2017 (i.e. you’d get about 3 months of accrued interest paid out to you immediately).

So it looks like debtholders will be paid off at $1.03116 per dollar of debt. The redemption will occur on December 30, 2016.

The choice of getting paid today vs. getting paid the same amount in three months is a no-brainer: take the money today and move on.

I have no idea where I will re-invest the proceeds. There was nothing nearly as “safe” as this specific debt issue. Any suggestions out there?

Canopy Growth Corporation

Canopy Growth (TSX: CGC), specializing in the production of marijuana, has gone parabolic.

cgc

Today, 12.9 million shares traded (about 10% of the company) around a level that valued the entire entity at around CAD$1.5 billion.

Fundamentally, looking at their last quarterly report, they have sold $15 million of marijuana in the last 6 months.

If you (exponentially) extrapolate their revenue growth curve, they will be selling over $1 billion in marijuana in five years.

Somehow, I don’t think this will happen.

I am predicting two things:

1. Management is going to do a massive secondary offering. They did two of them earlier in 2016 (raising an 8-digit sum of money), but they will scramble to raise an even bigger amount of money which would pay for a lot of marketing. I’m guessing they’re going to aim for over a hundred million. I’d do the same if I were in their shoes, in addition to personally selling shares at the earliest possible opportunity.
2. Eventually, within the next six months, a lot of people are going to lose money on this stock.

Right now, if you are short, I can imagine the pain. Maybe those short on the stock should get a prescription of medical marijuana to ease the pain.

No positions, no intention to take any, but looking at this stock with amusement.

Best ways to obtain gold exposure

The purpose of this article is to go over the various ways one increases exposure to the gold commodity. Clearly while investing in gold producers is another method, I will leave that for other smarter individuals.

The hypothetical investment is a CAD$10,000 or US$7,400 investment in gold. With institutional levels of capital, there are other facilities to expose oneself to gold. For the purposes of this article I am assuming a US$1,220/Oz price and a 0.74 USD/CAD exchange rate.

The largest gold ETF is (NYSE: GLD) and they are massively liquid. The MER is 0.40%. The next largest gold ETF is (NYSE: IAU) and they charge an MER of 0.25%. I would recommend IAU strictly on cost differentials – both have volumes that are well above retail levels. In terms of security, the custodian of GLD is HSBC, while the custodian of IAU is JP Morgan Chase. My very unprofessional ranking would put the two level in terms of security, hence IAU is the winner on costs. At today’s gold prices, you would be able to purchase 6.06 troy ounces and pay about CAD$25/year for the warm and snuggly feeling of it being safe. Purchase and disposal costs the price of a trading commission. GLD and IAU are denominated in US currency.

In Canadian currency, the best bet (and indeed, the only bet) is (TSX: MNT) which carries the unique feature of being backed by the Government of Canada and at an MER of 0.35% (thus a yearly maintenance of CAD$35/year). Its only apparent drawback is liquidity – bid-ask spreads typically are between 10 to 20 cents so this is not a product where you would want to place market orders. Each unit is currently equivalent to 0.0107125 troy ounces of gold. Purchase and disposal costs the price of a trading commission. MNT is legally an exchange-traded receipt (ETR) and they do trade above and below net asset value like ETFs.

Another option is purchasing the physical product. These suffer from three issues – divisibility of the product, transport, and storage. Looking at online vendors such as Kitco, you can purchase a 100 gram gold product for CAD$5,430. Pretending you can buy CAD$10,000 of product would result in 184 grams of gold or 5.92 troy ounces, which is a significant spread off market pricing. Getting it in one ounce gold coins results in a net gold mass of 5.86 troy ounces. Also, once you buy the product, you also have to pay to have it shipped (CAD$30) and insured (CAD$40 for a $10,000 purchase), which also adds to costs. Finally, it has to be stored somewhere securely – a bank safety deposit box is CAD$65/year at RBC, but these boxes are not covered by any insurance if there were circumstances that would cause them to be stolen or destroyed. Also, if the gold is to be subsequently liquidated, there will likely be additional frictional costs.

As a result, I do not believe that physical storage of gold is feasible on the retail level beyond trinket sums of capital.

The last option is using financial derivatives to emulate the price of gold. The best option is to use gold futures on CME. These are extremely cheap to trade and are liquid products, but suffer from the primary drawback of being in lots of 100 troy ounces. Margin requirements to hold a gold contract (US$122,000 notional value) overnight is US$5,400, so from a capital maintenance perspective, if your desire is to hold 100 troy ounces of gold, I would prefer utilizing futures. Clearly this is not a viable option if one’s intention is to invest CAD$10,000 in gold.

President Donald J. Trump – Immediate implications for Canada

I have been saying here since January 2016 and repeating ever since that Donald Trump will become the next president. Friends of mine will know the words out of my mouth back in August 2015, where I said “not only will Donald Trump win the Republican nomination, but he will become the next president of the United States” – and everybody else started laughing. “No, I’m serious! You laugh today, but just wait and watch”.

Making these sorts of predictions looks easy in retrospect, but there is a lot of genetic psychology that makes it quite difficult to be the one to stand out in a crowd with a very unconventional viewpoint (especially in a country where basically 90% of the people supported Hillary). Either you are regarded as crazy (as my friends clearly did), or shunned, or both. The funny thing is even when you are proven correct, those attitudes generally don’t change much. The only solace on marketable pieces of information such as this (or a lot of what goes on in the financial marketplace) is that correctly contrarian viewpoints tend to make a lot of money.

The markets have basically V’ed since the election (and indeed, I kept a real-time chart of the S&P 500 futures on my desktop as the election results came through, and it was very impressive how trading took it down and up on the returns of various polling stations in key states like Florida).

But there are some macroeconomic parameters that need to be factored into a Donald Trump presidency. While the US system is designed to make sure that you can’t enact too much change with a stroke of the pen (the US Constitution is an amazing structure demonstrating separation of powers), it is pretty clear that companies dependent on Canadian trade with the USA are going to have a more difficult time if there is any perception of protectionism in that particular industry.

Energy policy in the USA will be fairly obvious – there will be more friendly regulations concerning fossil fuel extraction.

In particular, in the political climate of Canada, Justin Trudeau already has staked a bit of his political credibility on his future relationship with Hillary Clinton, and that has now gone to dust. It will indeed be very interesting to see what happens when Trump wants to renegotiate NAFTA – the impression I will be getting is one if I was in a boxing ring with Mike Tyson.

The other quick conclusion I can reach is that it is more probable than not that interest rates will rise quicker than most people generally realize. My hypothesis for this is that the institutions behind the US Government are quite Democratic-party dominated at present and they will want to hamper anything that will come out of the President’s office. And the easiest way to do this is to starve the nation by raising interest rates. Watch the Federal Reserve this December raise rates.

So in general, we have the following parameters:
1. Sell long-term bonds or anything with medium to lengthy durations.
2. Long US dollars.
3. Get rid of anything Canadian that is US trade-sensitive.
4. Get rid of anything strongly dependent on Democratic-related domestic subsidies in the USA.

One of Obama’s legacies is saddling the nation with another US$10 trillion dollars in fiscal debt in his 8 year tenure. Even for a nation as rich as the USA, this is a lot of money (about US$30k per capita). This clearly cannot be sustained and unlike other forms of political actions, the direct connection to the standard of life and the increase in the nation’s debt is diffuse and won’t be felt until later – but I suspect the impact of the huge increase in debt will happen over the next few years.