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A Wealth Creation Journal

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Long read on US shale gas backdrop

How America’s most reckless billionaire created the fracking boom [Guardian] –  Bethany McLean on the shale industry & Chesapeake (CHK) founder

    • in 2008, conventional wisdom was that 8$ was a natural gas price floor (it cratered to 2.5$)
    • there was a real scare of US running out of gas before the shale revolution, with even Greenspan comments

“Landmen were always the stepchild of the industry,” he later told Rolling Stone. “Geologists and engineers were the important guys – but it dawned on me pretty early that all their fancy ideas aren’t worth very much if we don’t have a lease. If you’ve got the lease and I don’t, you win.” – McClendon, Chesapeake Energy founder

In my opinion, the US natural gas industry has become an interesting pond to fish in.

That other shale phenomenon, shale oil is actually the biggest risk factor for the price of US natural gas (i.e. cheapest fossil fuel globally, and cleaner than oil & coal). US Shale oil producers make their decisions based on the oil price. As a “side effect”, they also produce associated gas. This “free” natural gas competes with cheap shale gas producers in the US.  Interestingly, the US natural gas price is becoming counter-cyclical via the worldwide oil price. As the oil price suffers from an important demand shock in a recession, and shale oil producers are swing producers of oil, this growing competition of “free” associated gas is turned off (hence local nat gas supply shrinks).

In other words, while US shale gas producers are amongst the cheapest fossil fuel producers in the world, most US shale oil producers are almost the opposite (the marginal producers that turn off if oil demand retreats). As “associated gas” production of oil producers is turned off, this is very positive for US natural gas producers.

As credit markets are already shutting for natural gas producers (have a look at breathtaking multi-year plummeting share prices of AR, RR, CNX), a recession will probably put a damper on shale gas drilling (i.e. capex) growth as well. Lastly, demand growth remains underpinned by being the cheapest fossil fuel in the world. Meanwhile, US natural gas equities are very cheap compared to their prospective maintenance cash flows (20-50% yields) and SEC PV-10 reserves.  Both valuation measures give 0$ credit to the huge dormant assets convexity/optionality (no costs if US nat gas prices go down, but extra profits if nat gas starts rising). Of course these are commodity businesses with the usual disadvantages, except one! This idiosyncratic group of commodity businesses can’t be criticized as “cyclical” anymore. That is a game changer. More later.

“Simply put, low prices cure low prices as consumers are motivated to consume more and producers are compelled to produce less” – McClendon

Links

  • Booking.com thesis (excellent overview) – [the 10th man BKNG thesis]
    • I concur the valuation is compelling but I think this is borderline too hard. In my mind there is a >70% probability BKNG stock is a home run. In the other case, BKNG loses its edge relatively quickly (measured in years while it trades around 20X earnings) as Google keeps innovating & lowering the user friction to book directly with hotels (or any other OTA bidder, aka make the bidding process for ads in the Hotel Module – which is one giant & very user-friendly meta search ad – much more competitive & hence expensive for BKNG). If the user experience becomes better (and hence the search process for hotels and travel starts) on Google, then the legacy moat of BKNG is in trouble. The post does not elaborate on potential further Google innovations such as Google Assistant sorting out a booking with a direct AI phone call to hotels, passing on the parameters the user was looking for originally (hence lowering friction to book directly & getting a birds’ eye view on). Stratechery [The Google Squeeze] focused more on the latest innovation at least.
    • Google makes available a direct booking API for larger chains to easily plug into. That will increasingly happen to smaller hotels too. BKNG has painful take rates of 15% on hotel revenue

Google Hotel Module is making auctions for customer attention more competitive. As the real estate of mobile phone is limited, competitors get only one shot for attention in this superior meta search tool. The highest bidder is featured on top.

  • Druckenmiller 2020 Outlook [Bloomberg]
    • general takeaway: long equities, commodities (though not energy), short long duration fixed income (he is basically long inflation)
      • maybe not read too much into it as he reverses positions frequently
    • last takeaway: bull on UK domestic economy: “never underestimate the common sense of the British people” – Thatcher via Druckenmiller. Stan is a brexiteer, biggest FX long is GBP & says UK domestic stocks are at low multiples.
  • Peter Lynch in [Barron’s ]

 

 

 

Scribbles: KKR at the Goldman Sachs conference

  • 2X as much KKR investment professionals in RoW vs US.
  • 18 out of 22 investment strategy families less than 10 years old. Significant operating leverage on those (mostly) RoW people in young strategies
  • KKR Capital Markets: doing deals with third parties and being able to control the dealmaking and capture some fees, having a cap markets division is a competitive advantage that does not show up in typical alternative’s KPIs such as AUM, FPAUM etc
  • when KKR converted to C-corp, it stopped distributing 75% of distributable earnings. Today it is lower
    • Note I believe this is reason why KKR trades cheapish: the market prefers bird in the hand over compounding bird in the KKR stock bush, with supermajority voting stock etc.
  • KKR major player in Asia, biggest in terms of private equity funds, started in 2005
  • Most Asian investment professionals actually in India
  • Investing mostly in domestic consumption stories in Asia

 

Coming wave (next 1-2 yrs) of flagship fund raisings, chronologically:

  1. Asia PE fund
  2. Americas
  3. Infrastructure

 

Flagships will be additive to overall fundraising (last 3 yrs 90B of AUM raising without flagship wave, i.e. I believe only 1) and should be 30-40B USD in aggregate.  Everything else equal, 120B AUM raising in 3 years is possible (bull case environment maybe).

 

Odd lot split-off Danaher – NVST

If you buy 99 shares of Danaher through IBKR today at the US open, you’ll probably be able to tender these by the end of the business day (which is the deadline) for 5% more value in NVST shares. In two weeks you’ll get NVST shares delivered in your account.

Danaher is splitting off its 80% interest in NVST.

I am doing this unhedged, i.e. simply buying DHR and taking the volatility risk on NVST

Results may vary a lot, but 5% upside baked in is quite a high expected IRR for a few weeks of waiting.

 

 

 

 

Presenting a new blog post category: scribbles

The blog has been inactive for a while as the time hurdle to write down structured thoughts proves to be high.

From here we’ll post interesting notes, conference tidbits, thoughts in a more haphazard way under the post category “scribbles”.

We hope you’ll enjoy it.

Book review: Free Capital

I have never felt that investing is like working. It is more like playing ten parallel games of poker.

Peter Gyllenhammar

I recently read Guy Thomas’ excellent book “Free Capital: How 12 Private Investors made millions in the Stock Market” and learned a few things.

The book profiles 12 UK private investors who left their career to invest. I found the book an enjoyable and easy read.

The depth of the interviews is quite good. It’s easy to see the author is very knowledgeable in stock market investing (i.e. he’s an independent investor himself).

The book is agnostic on investment philosophy and there’s no larger narrative. Rather, the book is similar to the all-time classics Market Wizards or Inside the House of Money or John Train’s The Money Masters. The main difference is it profiles succesful non-“professionals”.

As the book does not have a big narrative, I’ll share some interesting concepts and quotes I picked up. The book is also full of “concept boxes” that explain certain touched-upon concepts. Even for seasoned investors, you will learn a few things. I will not share these.

Interesting thoughts, resource and quotes. Unsurprisingly, as an electrical engineer myself, the “hard science” investors’ thoughts resonated most:

  • most investors used the bulletin boards to share info with others ADVFN (which I find useful as well for our Dart Group plc position), Fool, iii.co.uk, stockopedia.co.uk

Investing is not like Olympic diving: there are no marks for degree of difficulty

Sushil
  • optimal betting size (i.e. Kelly Betting) is more cautious to downside risks than simply going by “expected returns” (i.e. probability-weighted return). Optimal betting uses logarithmic returns: while an investment with 50% chance of +25% return and 50% change of -20% has a 5% “expected return”, it has a 0% expected logarithmic return. Another way to see how an investor “gets” 0% and not the expected return is by continuously investing in the above 50/50 +25%/-20%-type of investments: +25%’s that are equally followed by -20% return 0% over time
  • Path-indendepent thinking: occupational identity can be a mental constraint. Don’t let your thinking be constrained by your identity.

I don’t seem to have very much influence on Walter. That’s one of his strengths: nobody seems to have much influence on him.

 

Warren Buffett on walter schloss
  • look for motivated sellers
  • better be right than consistent

The best decisions in the stock market attract no applause

Vernon
  • structuring your investments by writing down a brief 1) thesis 2) secondary factors 3) “hygiene factors” (absence of red flags)
  • investing is a game with negative scoring: avoid mistakes, learn from other people’s mistakes
  • optimal rate of error: it is not worth knowing everything about a company, because every point investigated has a time-opportunity cost. Your aim in checking “hygiene factors” is not to find out everything, but to reduce your error rate to an acceptable level

On talking to insiders and activism:

  • strategic naïvety: it can help to appear less sophisicated than you are. It helps persuade insiders to open up.
  • manage company meetings: at AGM’s, set expectations at the start of the meeting by informing insiders you have several questions to ask. Take note of who answers which questions and how they interact.
  • create a paper trail: putting your communication on paper makes it harder for directors to evade their fiduciary duties and ignore you

Another interesting – and complimentary – review can be found here.

TC

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