May 6, 2019 – Buffett Backs Occidental in Pursuit of Anadarko Takeover with $10 Billion Investment. How Does This Change the Takeover Battle Dynamics?
Beyond Meat Sizzles in Stock Market Debut. How Does the Stock Stack Up?
U.S. Job Gains in April Exceed Forecasts as Unemployment Rate Falls to Lowest Since 1969. Can the Economy Get Any Better?
The Fed Holds Rates Steady as Powell Claims Inflation “Transitory”. What’s the Fed’s Next Step?
Welcome investors to the Absolute Return Podcast. Your source for stock market analysis, global macro musings and hedge fund investment strategies. Your hosts Julian Klymochko and Michael Kesslering aim to bring you the knowledge and analysis you need to become a more intelligent and wealthier investor. This episode is brought to you by accelerate financial technologies. Accelerate because performance matters. Find out more at www.Accelerateshares.Com.
Julian: Welcome investors to Episode 12 of the Absolute Return Podcast. Today is Saturday May 4th, 2019, I’m your host Julian Klymochko.
Mike: And I am Mike Keslering.
Julian: And today is a special day for a lot of investors out there, they’re attending Berkshire Hathaway’s annual meeting got old Warren Buffett and Charlie Munger up there. 88 and 95 respectfully I believe, still doing it. I think about 40,000 people attend the meeting every year. Wish I could go this year but unfortunately just too busy. Got a bit of a shorter show this week was out in Toronto at the CAASA conference, family office conference got to talk about one of my favorite topics, which is replicating private equity with a liquid of public securities. Which we spoke about on last week’s podcast.
But on this week’s podcast a couple things to touch on that happened during the week, a few big news events. Speaking of Buffett, he backed Occidental to the tune of a 10-billion-dollar investment for its takeover of Anadarko. Which we’ve been talking about a lot lately. There’s a takeover battle there with Chevron. Beyond meat had an IPO and it really is sizzled triple digits in its stock market debut. U.S job gains an April exceeded forecasts by quite a bit as the unemployment rate falls to the lowest in about 60 years, 50-60 years and finally the Fed holds rates steady as Powell claims inflation is transitory and that transitory word was really a key part of his statement, so we’ll touch on that too.
I wanted to talk about this Buffett backing of Occidental to the tune of a ten-billion-dollar investment for its pursuit of Anadarko. As we previously discussed there’s this ongoing interesting takeover battle for Anadarko, a global oil player. But it’s really a key player in Permian Basin in the U.S, a big oil producer there – has a lot of growth in shale oil and really leading the US, that play is to now become the largest producers in the world. I believe the U.S. is now producing north of 12 million barrels per day, notching it above Saudi Arabia and Russia.
But on this deal, Berkshire Hathaway, Warren Buffett’s company, they committed 10 billion preferred stock plus warrant investment in Occidental and this is contingent on them winning this takeover war for their takeover of Anadarko. And to review Anadarko Petroleum is on the course to accept either a fifty-five-billion-dollar takeover from Occidental and that they deemed it likely to be superior to that of 50 billion previously friendly sale to Chevron. Occidental is one of the five largest U.S. Oil and gas production companies and their bid is roughly seventy-six per share. A twenty-two percent premium to Chevron’s bid which is around sixty-three dollars per share. What this does for Occidental it really makes them a more formidable competitor versus Chevron. Because Chevron’s enterprise value is roughly two hundred fifty billion and you look at Occidental and that’s more in the 50-billion-dollar range versus Anadarko which is also around 50 billion. We previously discussed how Occidental perhaps needed to complete subsequent asset sales. A number of investors in Occidental after seeing their share price decline came out against the deal. I know T. Rowe Price owns about 3%. They came out vocally against it. But this Buffett investment perhaps may allow Occidental to get around a potential shareholder vote. What are your thoughts on this one?
Mike: Yeah you mentioned that T. Rowe Price is against the deal. But they had also said that they were kind of offended that they weren’t given the same option to invest as Buffett and I think that’s, anybody would want those type of favorable deals.
Julian: He is a special investor. He has a halo effect and really no one has the name brand recognition that he has and that exactly is why he gets those deals. Not just that, but he can get a deal done in an hour in the tens of billions of dollars and really there aren’t very many other players that can do that with that sort of certainty.
Mike: Especially with regards to the timing is T. Rowe Price would not have been able to act as quickly. But in terms of the actual structure of his investment you’d mention that it is contingent on the company completing a takeover with an Anadarko. But the prefs will have a dividend of eight percent annually and can’t be redeemed for ten years. But when they are redeemed, they’ll be redeemed at one hundred and five percent of par value with liquidation preference and accumulation of any unpaid dividends kind of stat standard structure. But as well you’d mention the warrants to purchase eighty million shares of Occidental at an exercise price of sixty-two dollars and fifty cents per share.
Julian: Which isn’t even very much of a premium over the share price right. It’s 56 bucks a share I think?
Mike: Yes, somewhere around there and so if they recognize any of the synergies of this deal, that is a conservative estimate. But and as well in terms of the term that these can be exercised, they can be exercised up to a year after the prefs are redeemed. So, a maximum of about an eleven-year option on Occidental.
Julian: Yes, so the yield on this entire investment is significantly higher than eight percent just given the additional warrant equity kicker on top of the prefs and you want to compare that to the bond yield, Buffett – got a pretty sweet deal didn’t he here?
Mike: Yeah absolutely, their yield is about three and a half percent on their 10-year bonds. Obviously, those aren’t at the scale of ten billion dollars. So, there is a premium and pricing that you’ll have to pay as an issuer for that. But I don’t think that accounts for the entirety of that premium. Some of that is as you had mentioned the Buffett halo.
Julian: Certainly, and we mentioned Buffett getting a great deal here. He gets to put ten billion dollars to work. They just came out with their quarterly results Berkshire and I believe it showed a cash balance of around 115 billion. So, he still has quite a bit of cash to work through. But nonetheless he gets a nice yield on 10 billion that’ll last over a decade. So, he’s got to be happy with this one.
Mike: Absolutely and in terms of where you see this bidding war go next, what do you think? Cause there’s kind of a couple scenarios say Chevron ups their cash portion of their offer to over 50%, similar to Occidental. But then now Occidental can increase their cash portion of their offer. So likely there to be a price increase or what are your thoughts?
Julian: Well certainly the Buffett investment gives substantial heft to the Occidental bid. A lot of people were concerned, and the Anadarko board was concerned with respect to execution. Just knowing that they were relying on these subsequent asset sales, they were relying on bridge financing and things of that nature. But having Buffett’s backing and his balance sheet behind the bid, that certainly makes them competitive.
So, I think the next steps I believe Chevron will likely match if Occidental’s bid if it is deemed superior. Which looks like it likely will be and at that point the ball is really in Occidental’s court. Do they want to increase above their current seventy-six per share bid? Obviously, some of their shareholders already upset with the current bid. If they got to go even higher for Anadarko, there’ll be further pushback. So that also depends on how they structure this. Can they get around a shareholder vote which is needed to approve the issuance of shares? So, a lot of interesting dynamics there. We’ll see how this one plays out over the next few weeks. But clearly Anadarko shareholders get to enjoy a competitive bidding war between two pretty heavyweights and I also mentioned the other notion of bidding wars are always the best when it’s a unique asset and I think Anadarko’s top-tier position in the Permian Basin, it does give them some of that uniqueness. Now the Permian Basin really has driven you know millions of barrels per day, increase in the US oil production over the past say five years. So, it really is a marquee play in the U.S and clearly this deal shows that there are a number of players keen on increasing scale in that play and that’s where Anadarko really could be a kingmaker.
Big IPO this week with Beyond Meat absolutely sizzling in their initial public offering up over a hundred and sixty percent on its first day of trading. Now this one hundred sixty three percent IPO pop was one of the largest that we’ve seen in a long time. In fact, the fourth highest IPO pot for a U.S listed IPO greater than a hundred million in the post dot com bubble era. The other three that beat it one was called Ceres in 2015, up a hundred eighty six percent on the first date. Dicerna in 2014 up two hundred seven percent. Lastly Baidu, in 2005 up a stunning three hundred and fifty four percent. So, this deal was done at twenty-five dollars per share. The IPO, it opened at roughly forty-six well above the IPO price surged to fifty within minutes. Traded as high as seventy-two bucks per share, closed at sixty-five seventy-five. A lot of wild price action on this one. But clearly mispriced by the investment banks. They initially went out with the range of 19 to 21 bucks per share looking to raise 184 million, that got increased. The range got increased from 19 to 21 to 23 to 25 and ultimately priced at the top of the range. But that seemed to be a mistake since it closed at just north of 65.
The company Beyond Meat sold 18 and a half percent of its shares at 25 bucks per share to raise about two hundred and eighty million bucks. So, you had dilution of nearly twenty percent and I say it’s a mistake on the part of the investment bankers how they mispriced this, given that it was far too cheap. Much lower than the market was willing to pay as you saw from the price action and 163% increase on the first day of trading and what this cost the company was roughly ten percent additional dilution, had to sell ten percent more of the company. Because they sold 18.5 percent at twenty-five bucks, but they could have raised the same amount of money at sixty-five bucks per share but only selling eight percent of the company. Pretty pricey mistake in my opinion you know with respect to an IPO you do want to see some lift to reward investors taking the risk in buying new shares. But you don’t want to leave that much money on the table and the company’s got to be pretty upset with that one. What are your thoughts on this IPO here?
Mike: Yeah and in terms of the pricing, also the first trade when once it did open on the market, now obviously the IPO was priced at $25. But the first trade was actually done at $46. So even there almost a 100 percent jump. But as a little bit of defense to the investment banks is that in terms of their fundamentals, they lost thirty million dollars last year. Which is not uncommon for a start-up to have losses? But they only had revenue of 88 million dollars last year, which was growing at about a hundred and seventy percent. But looking at the valuation now of the current valuation of well the IPO was priced at 1.5 billion dollars, which I thought was steep for 88 million dollars of revenue. But now looking at the valuation about 3.7 billion dollars on 88 million dollars of revenue. I guess you could kind of understand why the investment banks perhaps weren’t willing to go as high as they genuinely must have didn’t think there was as much demand for this.
Julian: Yeah. What is that, roughly fifty times sales for a food producer?
Mike: Yeah, absolutely, and in terms of some of the rationale for this really high valuation is that they do actually, they’re growing at a massive rate. But as well they do have slightly higher gross margins already than Tyson Foods. So presumably well based on the valuation they will be adding a substantial amount of scale, which will result in ideally those gross margins increasing.
Julian: Yeah and Tyson Foods being one of the largest competitors in the space.
Mike: Yes, well the largest meat producer which was a former investor they actually held a six-point five percent stake in Beyond Meat that they sold prior to the IPO, because they were planning to develop their own product.
Julian: And by stake, no pun intended. Because Beyond Meat produces vegan burgers, so we call it fake meat. But they call it Beyond Meat.
This stock is my definition of a story stock. They sell the story of plant-based substitutes for meat. It’s gaining a lot of popularity as people shift toward vegan or vegetarian diets, there’s concerns about health risks from meat, animal welfare, environmental hazards. They say beef causes a lot of greenhouse gases. It’s bad for the animals obviously and so they really have you know one of these page-1 stories behind the stock and that’s probably why it’s trading at fifty times revenue. But ultimately you got to look at the business, it is a food producer. Capital intensive, asset heavy, requires a lot of capex to grow. It’s not one of these SAAS type businesses where you can easily grow revenue without significant capital expenditures.
Mike: Absolutely and in terms of the mentioning their gross margins and kind of the thesis that while they have about twenty percent gross margins, I believe Q1 increase to 25 gross margins. But the expectation that those continue to increase, maybe a little bit misguided. Because right now there’s really only two major competitors in the space themselves and Impossible Foods which has, Impossible Foods has a partnership with Burger King among other they have the impossible whopper. But they themselves have raised about four hundred million dollars in financing. Some of the same investors from Beyond Meat are in that cap table as well. So, they not only are they producing an alternative, but so is Tyson Foods.
So, in comparison to a business model that would have substantially higher gross margins as well as a kind of winner-take-all platform style business, I don’t see that with beyond meat is that this is going to be a very competitive marketplace. These high margins that they’re getting right now I think are going to, they will get the benefits of scale on the cost side. But on the price side I just see there being more competition.
Julian: You really nailed it here. I think it’s a case of substantially more competition coming into the market you have what I consider no real sustainable competitive advantage, no competitive moat in this business. I think ultimately these vegan-based meat or meat substitutes will ultimately become commoditized and you’ll see similar margins, similar profitability to you know your standard food producers. Which ultimately have a multiple in the market at a small fraction that Beyond Meat was awarded in its first day of trading.
Mike: I think Tyson Foods, their enterprise value is forty billion dollars and they had forty billion dollars of revenue last year. So, a one times multiple.
Julian: Exactly, versus fifty. So perhaps you know substantial downside when things normalize there, and you know watch out for this stock. I think there’s a lot priced in and when there’s a lot priced in and the story doesn’t play out as expected or as those projections as investors expect, then there tends to be substantial downside in these sorts of story stocks.
U.S jobs numbers exceeding forecasts in the April as unemployment rate falls to the lowest since 1969. Getting down to the numbers the U.S had two hundred sixty-three thousand new hires in April. This easily beat the Wall Street consensus expectations of 190,000. It’s a big beat there. Unemployment rate fell to three-point six percent versus previously at three-point eight percent. Now three-point six percent is the lowest since 1969.
Obviously, the economy roaring pretty good here. Another number within that the jobless rate, it was helped by not just the increase in hiring, but a sharp decline in labor force of nearly a half million people in the labor force. So that’ll bring the unemployment rate down, not necessarily a positive thing. You want to see a growing labor force, not necessarily a shrinking labor force.
I want to touch on another thing, previous month revisions. We previously talked about, you really can’t take any one of these numbers as set in stone. They always get revised, they’re quite volatile and they’re based on surveys. Looking back to February it was that really really low number of 33,000. This actually got revised up to 56,000. So nearly doubled on its revision. March was reduced to one hundred eighty-nine thousand from one hundred ninety-six thousand. But year-to-date which I like looking at say a three-month average or something of that nature. Year-to-date job gains have averaged just over 200,000 per month. Which is certainly a very strong number and signals a really strong economy in the U.S. What are your thoughts?
Mike: Yeah it certainly is a very strong economy right now with you know we’ve talked before about the Q1 GDP numbers, three-point two percent growth on that side. So strong growth there. But as well I wanted to mention that hourly earnings growth is actually increasing at about three-point two percent as well. Which is above the core inflation of around I believe that’s one-point six percent. So, what you’re seeing is that, sorry not earnings power, buying power is actually increasing for workers in in the U.S. which is you know in terms of the, it’s a really good thing for those workers that they’re able to buy more with every dollar of their earnings.
Julian: Yeah which is really interesting and that provides a nice transition to our next topic. You have the lowest unemployment rate in 50 years, you have a roaring economy, great job growth, great income growth on behalf of workers. But you’re not seeing that in consumer price inflation and that really puts the Fed here in a bind. And so last week the Fed held rates steady as Powell claimed that inflation was quote transitory. Now this key word “transitory” was really taken and analyzed by market participants and really just talked about a lot. So, what happened was the Federal Reserve held steady on rate hikes this week as the core inflation came in quite a bit lower than expected, one point five five percent, declined from one point nine five percent. And what the Fed is looking to do is they want to CPI or inflation at their 2% inflation target.
Looking at the really strong economy and jobs growth and now income growth, they’re really confused, and they don’t understand why they’re not getting to the 2% target. The market is understanding this as look you’re not at the 2% inflation target, you want to get there so perhaps you’ll need to cut rates. But what Powell indicated with his inflation is transitory comment here is that perhaps he’s not leaning towards a rate cut, but perhaps he just wants to continue to hold rates steady on a go-forward basis and see how things play out. Perhaps these transitory factors actually you know do come to fruition and inflation picks up again.
Mike: Absolutely. In terms of that transitory approach and being data-driven, it’s just a rational response where I guess I’m a little bit confused by the market expectations here where some of the commentary implies that he’s not even thinking about cutting rates. Which isn’t how I read his comments. His exact quote was we do think that our policy stance is appropriate right now. We don’t have a strong case for moving in either direction. Which more just seems like a rational approach. They’re weighing both possibilities not that anything is off the table.
Julian: Yeah, the other interesting thing is he described low inflation as this transitory as we discussed, not persistent. He also mentioned that the central bank would consider policy moves i.e. a rate cut, if inflation was persistently low. So, you really got a deviation in language there and he really focused on key words. The other thing to note about Powell is, market participants claim he had you know errors in communication. In the past as we previously discussed in Q4 he indicated that rate hikes would run on autopilot, the Fed’s balance sheet runoff was on autopilot as well and those would keep their direction and then we saw the S&P 500 tank 20%, Donald Trump got very upset. Everyone one was begging him to you know reverse course and ultimately, he pulled a full 180 in early January of which you see the result and that’s roughly 25 percent rally since the Christmas Eve lows and the S&P 500 taking the market to a new all-time high. It really shows the importance of the Fed, how much effect they do have on markets, equity prices not just that but also bond prices, bond yields, currencies and effectively the whole global market.
Mike: And with regards to his communication with the markets it seems that at one point or another throughout the tenure of any chairman or chairperson, they have been criticized for their communication with the markets. So, I don’t read too much into that. Like it’s a common criticism in this position. Because you do have to choose your words very selectively and it can be a little ambiguous. But the other side is that you know although they aren’t at that 2% inflation target, they’re at 1.6 percent. So that was a decline from the previous reading. But it isn’t, you know it isn’t in deflationary territory. It’s not sub 1%. So, I think you know pumping the brakes a little bit, not panicking over the language would be the prudent way forward.
Julian: The other interesting concept that you hear from some economists is the notion of increasing inflation target to perhaps 3%, running the economy hotter thea you know previously done with the 2% inflation target and see how things play out there. You obviously had big you know fiscal deficits, a lot of spending under Donald Trump and speaking of Trump he’s still out criticizing a Fed policy. On Tuesday he indicated that Federal Reserve policy was holding back the US economy. He actually said the Fed should cut rates by a hundred basis points, one full percentage point and restart a program of QE, or quantitative easing, which was really only needed to get out of the Great Recession a number of years ago. That was a policy tool used during the financial crisis and you got to look at that and you know think what knowledge he has. Because typically these tools, large rate cuts, quantitative easing you don’t want to use those tools in one of the fastest-growing and greatest economic environments ever with unemployment at a 50-year low.
Mike: Yeah that would effectively be the equivalent of a bazooka and so if you use that right now with these kinds of strong numbers that we’re seeing, then what do you have when things really do get bad?
Julian: Yeah, it’s not just that. But if you really stimulate the economy when it’s already doing very well, then you do risk higher inflation. It’s kind of throwing gasoline on a fire and to your point typically these policy tools, rate cuts, quantitative easing, are used counter cyclically, i.e. to get the economy out of recession. And when the economy is really chugging along, that’s a point in which central bankers and governments really want to take a step back, lay off the throttle with respect to their stimulative measures.
And that’s it for Episode 12 of the absolute return podcast. You’ll hear back from us next week. To anyone at Berkshire Hathaway’s meeting hope it’s going well and I’m sure we’ll be talking about that on next week’s podcast. Be sure to follow us on Twitter, check us out at AbsoluteReturnPodcast.com for additional episodes and we’ll chat with you next week. Cheers.
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