September 9, 2019—Canada Notches Best Quarterly Economic Growth Since 2017. What’s Behind the Numbers?
Brexit Drama Reaches Comedic Levels as PM Boris Johnson Faces Defeat. Is Brexit Ever Going to Happen?
Investors Balk at WeWork’s IPO as it’s Forced to Slash its Valuation. Will They Scrap the Whole Thing?
NBA Considers Creating an Investment Fund to Hold Stakes in Pro Basketball Teams. Should You Become an Owner?
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 Klymochko: Welcome investors to episode 30 of The Absolute Return Podcast, I am your host Julian Klymochko.
Michael Kesslering: And I am Michael Kesslering.
Julian Klymochko: Today is Friday, September 6, 2019, the first podcast of September. I hope everyone had a great summer. Got a number of important topics to talk about on this week’s podcast, specifically:
- We are going to chat about economic conditions in Canada, put out some pretty good economic growth figures along with jobs numbers this week. We are going to chat what is behind the numbers there and why the Canadian dollar is rallying this week.
- Some real Brexit drama. It reached comedic levels as PM Boris Johnson faced defeat in parliament. Is Brexit ever going to happen?
- Investors balked at WeWork’s Initial public offering as it’s forced to slash its valuation by over 50 percent while they end up scrapping the whole thing altogether.
- Lastly, we are going to chat about the fact that NBA, the National Basketball Association, is considering creating an investment fund to hold stakes in professional basketball teams. Should you become an owner?
- And we’re just going to talk also about professional sports team ownership in general and how you can access that as an everyday investor.
Important week this week in Canadian economic figures. We basically had three major economic data points coming out this week. That is quarterly GDP growth; we had a big Bank of Canada decision on interest rates, and lastly, a jobs report today. We are going to start with the Q2 economic growth figures. I mean, it really smashed expectations. Huge number, three point seven percent-annualized GDP growth, which is the largest since 2017. Significantly, ahead of the Bank of Canada’s two point three percent forecast. Some contributing factors behind that very strong GDP numbers, mostly energy production, which was up five point seven percent in addition to housing activity. Now, the major implication of this strong GDP print is causing economists and analysts to push back their rate cut predictions for the Bank of Canada as we now central banks throughout the globe have been cutting rates. You saw the U.S. Fed recently cut rates and they are expected to do so again. Many other central banks globally have been engaged in a rate cutting cycle, but not yet for the Bank of Canada. This week they announced that they were ahead, keeping rates steady at one point seventy five percent, which was really in line with expectations. The market was not really forecasting a rate cut this time, however, the Bank of Canada made several references to the worsening effects of trade tensions on the world economy. This is really just suggesting that the Bank of Canada is prepared to cut rates if necessary. However, they’re not really there yet, which is really makes them stand out really on their own with respect to pretty much every other central bank in the world who is pursuing, not pursuing an easing cycle.
Bank of Canada Governor Stephen Poloz and his advisers, they are weighing the relatively positive domestic economic figures. One is this Q2 GDP growth number not just that, but also very stable inflation right around their 2 percent target there. They are contrasting this with rising global threats to the world economy, including Brexit, which is one thing the U.S. China trade war, which is really looming and causing, you know, a slowdown in economic activity globally. Quote from the BOC: they are indicating that “Canada’s economy is operating close to potential and inflation is on target.”
They believe everything is smooth sailing. However, you know, they are aware of these global risks out there. Like we said, a number of things, the potential threats on the horizon, such as the impact of these trade wars and the slowdown in global growth, whether it’s various PMI figures that we’ve seen. A lot of weakness out of Europe, specifically Germany, which is really driving the European economy. Nonetheless, we go back to market expectations. The BOC meets again next month on a rate cut decision and the market’s pricing in basically a 50 percent chance that the Bank of Canada is going to cut rates. However, that was before the jobs numbers came out, which really knocked it out of the park. They announced 81000 jobs created last month, which in my opinion is pretty hard to believe. As we discussed, whenever these Canadian jobs numbers come out, you have to take them with a grain of salt and be sceptical about them. They are all over the place. I mean, in July, we had 24000 jobs lost. I never really put a lot of stock into Canadian jobs figures. I like to look at averages and year to date; we are averaging 38000 jobs per month, which is pretty strong. I mean, I like comparing it to the U.S. figures. See if we can 10x that, U.S. jobs came out this morning as well and I believe 130000 bit below consensus. Nonetheless, Canada’s economy seems to be hitting on all cylinders. What do you think of these strong economic job numbers and the outlook for rates in the currency?
Michael Kesslering: So starting with the jobs numbers. I would like to point out that a lot of the increases were in part time jobs. So, you know, that is different than full time employment in terms of just the overall sustaining impact of those jobs. The other aspect that I would like to point out, you had mentioned that you like to look at the averages and the trends. Another thing that I like to look at is the wage growth, especially when it relates to inflation. It is something I have pointed out before. Yet again, we do have wage growth outpacing inflation where it is at about three point eight percent, and really, that is just the purchasing power. Increasing for everyday Canadians, which is important to look.
Just touching quickly on the GDP numbers is like you had mentioned, it is interesting to see such a difference between the actual and the estimated. Typically, the economists are not that far off with something like GDP. That is interesting to note as well as with the GDP numbers that the increase in energy exports, which was a major driver of this. Just points out, how sensitive we are and this was largely driven by higher commodity prices. Just does show how sensitive Canada’s economy is to commodities.
Then lastly, on the BOC, one interesting point of analysis that came across with regards to why the BBC didn’t cut rates could be because of the high levels of household debt in Canada, with the view being that a cut would it incentivize more borrowing? And just to put that into perspective, Canadians have about two point one six trillion in debt, which as a percentage of GDP is actually just over one hundred percent, which is the highest of G7 countries. And to put that into further perspective, the U.S., which is traditionally viewed as a country that takes on a lot of debt at the consumer level and the corporate level is at about 76 percent of GDP, which is, you know, something to really consider in Canada’s really high debt levels.
Julian Klymochko: Right, and one reason that the BOC is kind of not rushing to cut rates is that, as you indicated, debt levels, which is largely correlated with housing. Housing prices in Canada have gone up a lot, specifically in Vancouver and Toronto, the two biggest cities. And with that, they are concerned that many consumers are potentially over leveraged and they don’t want to cause that to get even more extreme by making it, you know, easier to support a larger and larger debt level with lower rates. Nonetheless, you know, they can only do so much. What we are starting to see is really just a global easing cycle from central banks. Canada cannot be unique forever, you have to take into account that perhaps this recent economic data is somewhat of a statistical anomaly. We will monitor it to see now how long can they keep putting up these strong economic figures, whether it is GDP, whether it is jobs. And with respect to that, that will affect the market’s perception on the probability of rate cuts, which will ultimately affect the currency. Nonetheless, these economic figures better than expected. Therefore, you see the Canadian dollar rallying after this unexpected jump.
More hilarity ensued this week with additional Brexit drama. What happened was a British PM, Boris Johnson; he faced a humiliating week on a number of fronts as MP backed legislation that would block his hard Brexit plan, as we know. Boris Johnson really came into power promising voters to execute Brexit on October 31, even if there was no plan to go along with it. In addition, MP has stopped his attempt to call an election to push forward Britain’s exit from the EU. Specifically, Tory Rebel MP has joined forces with the opposition to approve a Brexit delay bill. What this did effectively, it aimed at blocking a no deal exit at the October 31 deadline.
In addition, his motion to secure an election to push forward Brexit also faced a humiliating defeat. Johnson, he claimed that the manoeuvre would ultimately hold Britain, in a Brexit limbo for many years to come, which I mean you look at Brexit. It has been happening for three years since the referendum happened, and how much progress have they made? Effectively, none. They have just been spinning their tIres month in, month out for three years already and have accomplished exactly nothing. To summarize PM Boris Johnson’s week, well, he faced his first votes in parliament and lost them. Second, he lost his minority government’s governing majority. Third, he sacked 21 of his own MP’s, including his party’s longest serving member, who also happened to be Winston Churchill’s grandson. Fourth provoked his own brother into resigning from cabinet, citing a conflict between family loyalty and national interest. Lastly, he lost control of the House of Commons while remaining so outside the chamber’s confidence that will not yet allow him to resolve the matter by calling an election.
To summarize, I wanted to comment on some market action that the British pound the GBP bounced back one point four percent on the day. As you know, Brexit is horrible for Britain’s currency and so it had a little bounce, more of a dead cat bounce. It has been tanking along with Brexit here and the betting markets in the UK. They have betting markets where you can bet on a whole host of things and many Brexit outcomes you can bet on, one is the odds of a hard Brexit come the October 30 first deadline. Well, the odds of this plummeted from 50 percent to now 17 percent. So they are really pricing in a small chance of a hard Brexit on October 30 first. The most likely outcome is a 45 percent chance on a Brexit extension. We can all look forward to more Brexit nonsense. Post the October 30 first deadline, which I believe is now the third deadline. What are your thoughts on this hilarity that is happening in the UK politics?
Michael Kesslering: Hilarity is the correct way to describe it, but I also just wanted to go back to his removal of the 21 Conservative MPS, and this was because they had voted against his government in another Brexit vote. The kind of funny part about this is that as soon as he had let these people go and removed them, he was facing backlash from his own party, where he immediately then behind the scenes from sources said that he was looking for ways to bring them back as it was a show of a weakening government. Really, it just seems like everything is going and all sorts of directions. Honestly kind of hard to follow along with all the twists and turns that are going on here if you focus on the daily minutia, but really all that’s happening is coming back to the centre of that initial Brexit vote, it really wasn’t decisive that everybody wanted to do a Brexit. It really just comes back to that where I believe the majority of the populace really does not want this.
Julian Klymochko: Or they want to not be part of the EU but keep all the benefits. Now they are realizing, hey, if we exit the EU, there is all this economic damage and there is tons of jobs are going to be lost, incomes are going to decline. Our way of life is going to decrease in value.
Michael Kesslering: Especially for travelling.
Julian Klymochko: Yeah, and perhaps they are having second thoughts. It certainly is not turning out how Brexit was initially pitched to them and people are really starting to catch on. But as for the effective execution of this, it still remains to be unseen. Three years into the Brexit process and there really is no more clarity than there was on day one.
Interesting news in the IPO space, we are going to comment a bit on WeWork anticipated or now so not so anticipated initial public offering, what is happening here is that investors have really balked at WeWork IPO specifically in addition to all of the corporate governance matters that we talked about on last week’s podcast. A big issue here is on valuation, so Wework initial public offering remains a tough sell with investors and it is considering slashing its valuation by over 50 percent from recent forty seven billion, which is where Softbank Vision Fund invested in a private round of WeWork recently. They are considering slashing this value to 20 billion, in order to overcome investor scepticism, and make this IPO successful.
Getting into Softbank now, Softbank owns about twenty-nine percent of WeWork and Softbank has ploughed over 10 billion dollars into WeWork already. So ten point six five billion into it. Now, what we like to do is look at comparable just to see how things shake out from the valuation on a valuation perspective. If we look at publicly traded IWG, which owns comparable coworking company Regus, and you can see Regus facilities around any major city and they are very, very similar to WeWork. Now Regis, their parent IWG is valued at only 12 billion, however, Regis has 3000 locations WeWork has 528. IWG has three point one billion in revenue versus WeWork one point eight billion. So nearly, twice as much revenue and we work as trying to have a valuation that is nearly twice as high as IWG or four X on EV per revenue basis. In my opinion, if we look at these numbers and compare it to IWG Regis, then I believe you know, a more rational and fitting valuation for WeWork would be roughly around 8 billion. I believe that this 20 billion down from forty seven billion is still far too high and they still need to cut it by over 50 percent to be successful such that investors will actually buy the IPO. But you take that and frame it with respect to Softbank ten point six five billion investment for a 29 percent stake into WeWork.
Now if we say that 100 percent of WeWork is now only worth 8 billion. What that indicates is that WeWork is a massive incinerator of capital. It is actually worth significantly less than all the money invested into, not just that, but Softbank is really, really underwater on their investment here, which has tremendous implications in my mind because Softbank is out trying to raise a second vision fund, which they want to be north of 100 billion dollars. They want to have high performance for their first vision fund, and WeWork is really, you know, a trophy investment of their first vision fund, and they are out pitching, you know, this great performance off the back of a WeWork valued at forty seven billion. Well, how is that? WeWork performance going to look, when it is marked at 8 billion. So in my opinion, you know, is this IPO going to happen or is Softbank going to stop it just so they don’t after re mark or mark to market their book to capture this massive valuation decline at WeWork. It is an ongoing situation. What are your thoughts on this whole IPO disaster at WeWork?
Michael Kesslering: Yeah, and with regards to Softbank, is not only are they heavily in Softbank, their vision fund number one, not only are they highly invested in WeWork already, but also their other main investment Uber, they are reportedly down 600 million at current prices in that investment. They really need WeWork to work out. Sorry about the phrasing there, but in terms of as well. One thing that we had not mentioned in the initial WeWork episode was that they actually really are not that sensitive to their valuation because what they really need is a six billion dollar credit facility from their lenders, which is contingent on raising at least three billion dollars.
Julian Klymochko: Right, the 6 billion dollars.
Michael Kesslering: Yes, so what they really need is in order to get 9 billion dollars potentially, because they are losing a lot of cash through their operations. Is that it is not exactly the valuation that they are sensitive to. They will do their IPO or fundraise at whatever valuation as long as they can raise that 3 billion dollars, so puts an interesting dynamic between WeWork and Softbank, where Softbank is very sensitive to the valuation, WeWork not so much. The other interesting aspect and one other thing that we had brought up in the previous episode was Newman’s deal with the We trademark, where he was given five point nine million dollars.
And that actually wasn’t in cash. That was actually in shares of the company, but regardless of that, likely because of investor backlash over their governance, he did give those shares back, which really was not announced by the company. It was just in their refiling of their S-1, they just left that out. The other interesting aspect that I thought I would highlight is that Newman was actually speaking during an analyst roadshow here this week, and he kind of bragged about the support that WeWork has from Wells Fargo, which is their lead lender in the credit facility. Because of this, his explanation was that Wells Fargo is really persuaded by the company’s positive unit economics. However, they really don’t provide the sort of granular location detail in their prospectus for public investors. You just kind of have to take it on faith, and if they did have positive unit economics, you would think that they would highlight that in the prospectus as that’s a main concern. What I really think is that the creditors are mainly focused on the three billion dollar equity buffer less than the unit economics. It is just a really interesting situation, I’m really intrigued to see how it plays out.
Julian Klymochko: Right and I think investors really need to give significant consideration to the type of investment this is. I consider WeWork the type of business that is highly sensitive to capital markets. They are burning a ton of cash and they continually have to access capital markets. Thus far, they have done it on the private side, but now they are looking to come public. And so there’s a lot more scrutiny on them, there short sellers on them and they’re trying to get debt, more debt. They are levering up, and if the capital markets ever loses faith in the story, it is really pretty much impossible to recover if your stock is tanking, because now it is on public display. Everyone knows and a lender is going to look at your stock price. They’re seeing a crash, no one is going to want to lend you money. It really goes to the concept of reflexivity, which is theory by now, famed investor George Soros. Reflexivity, you can sum it up pretty much, you know, historically or fundamentally. Typically, how stock prices work is that fundamentals affect the stock price. But what reflexivity indicates is it’s not just fundamentals affecting price, but price affecting fundamentals. This is a very, very important concept for WeWork and other highly sensitive capital markets, focused companies that require continued injections of capital and higher and higher valuations. Is that if market ever loses faith, then, you know, the stock price tanking and the loss of access to capital can affect the fundamentals of the business tremendously. And we’ve seen time and time again when that happens and they lose that access. Many companies end up going to zero end up going bankrupt because they cannot fund those losses.
Michael Kesslering: And just to build on that thought is that WeWork has really been focusing on their enterprise customers. So bringing in large corporations and managing their office space for them. IBM is a good example of that, in what could result if they are a public company. If those potential folks having their property manage by WeWork, see the share price go down, that could give them less confidence in having WeWork, manage their property and have another area of negative feedback loop there.
Julian Klymochko: Right, and so this share price is effectively a public scorecard, which tells a lot about the company. It can really affect the faith not just of investors and employees, but also lenders and also a potential business partners. That is something really to keep in mind; you are going to have a lot of attention from short sellers on this stock. I happen to think that it might be a very good short if and when it does become public. I think just given all the issues, all the drama and the lack of public market support at pretty, much any valuation, looks like it is still going to be a tough sell at the 20 billion. I think there is actually, now a good chance that this IPO could get pulled and they won’t be going public anytime soon, but we shall see.
So you want to be a sports team owner? Well, there may just be another way to accomplish that dream. If it is in fact, your dream, because the NBA is considering creating an investment fund to hold stakes in some of their pro basketball teams, basically what they’re trying to do is capitalize on the soaring value of their franchises. In addition to providing liquidity to some of their owners, a quote from the NBA here, “they indicated that this vehicle would provide additional liquidity for the sale of team ownership interests, including by providing access to a new pool of long term investors that do not currently have access to team ownership opportunities.” Now, sports team ownership is traditionally. At least in the last 10 years, been, you know, the playground of billionaires. We have seen sports team values skyrocket into the billion dollar ranges. Some recent transactions just in the news last month, the Brooklyn Nets just sold to the co-founder of Alibaba. I believe Mikhail Prokhorov sold his 50 percent stake and he is a Russian oligarch. That team sold at a valuation of two point three billion dollars, which was record. In football, NFL team Carolina Panthers are sold to hedge fund legend David Tepper for two point three billion. That was it by believe within the last year, some other data points, actually, regular everyday investors can own a stake in the Atlanta Braves. I actually own this because it is a publicly traded stock. It is owned by Liberty, but Liberty took it public a number of years ago. I bought the stock I believe I owned zero point zero, zero, zero one percent of the Atlanta Braves.
Michael Kesslering: A minority shareholder.
Julian Klymochko: I can brag, to friends and family that I was a professional sports team owner. I check that box off the old bucket list. The Atlanta Braves, you can go into the market and buy their stock at only 28 bucks a share. This values the Atlanta Braves at one point eight billion dollars.
There is a couple other ways to find ownership in the public markets. Some of your favourite sports franchises, one, if you are a hockey fan or basketball fan, Maple Leaf Sports & Entertainment. They are a Canadian company owned by BCE and Rogers, both of which are publicly traded in Toronto. Now Maple Leaf Sports, they own both the Toronto Raptors and Toronto Maple Leafs, so that is other way investors can get access to it.
And why would investors, want to own a professional sports franchise? Number one is bragging rights. People like, you know, it is very soothing to the ego to be able to say that you own a professional sports team. The other thing is, you know, historically they have provided very good returns, and this is not from a cash flow perspective. Typically, investors are unable to; really extract any sort of dividends. They don’t really produce any free cash flow, but we have seen historically that the returns have gone up over time.
If we look at the NBA and, you know, with a topic that the NBA is considering creating a fund, they have, every single team is worth well over a billion dollars. You have at the top the New York Knicks that recently valued at four billion. I believe, according to Forbes, this is their latest ranking. You had the Toronto Raptors, which is part of a publicly traded BCE and Rogers, valued at one point seven billion. However, after winning the recent championship, that valuation is sure to go up, and at the very bottom, the lowest valuation is the Memphis Grizzlies. But this will still cost an investor one point two billion dollars, but certainly a really interesting potential opportunity for investors if the NBA does, in fact, create this fund for smaller investors to get a piece of NBA team ownership. What are your thoughts on this?
Michael Kesslering: So first, I just wanted to point out the growth in team valuations over about the last 20 years. The average team valuation in the NFL has actually increased about 11 percent year over year over the last 20 years, which is which is quite interesting. As you mentioned, there really is not much for income distributions paid out. But that doesn’t include any of those distributions, If there was any. But what’s interesting in that is that the lowest value of a team is actually in terms of a valuation on an estimated EBITDA basis is 13 times, which is a fairly high EBITDA ratio. Moving over to the NBA, they have actually been increasing at twelve point five percent compounded annually over the last 20 ish years. And so what is the reason for some of this increase? Number one is TV deals, so say in the NFL each year this year, it is estimated that every team will receive two hundred and fifty five million dollars. You can compare that to 116 million dollars in 2010 and 83 million dollars in the year 2000. Now, that does not account for all of the growth in team valuations. The other aspects are merchandising and licensing deals, which have become very popular in both the NFL and NBA, as well as rising ticket prices. But rising ticket prices really make up kind of a small amount of that team value when you look at that, and the other aspect being stadium deals is municipalities have been willing over the last 20 years to give sports franchises really sweetheart deals.
Then the last thing I did want to point out with regards to differences between the NFL and NBA is just restrictions in the ownership policies. In the NFL, the primary shareholder, the main owner has to own 30 percent of the equity now in the NBA that is only 15 percent. So if you are looking at these team values and keep in mind that in the NFL, you are only allowed to put on three hundred and fifty million dollars’ worth of debt. So really, in terms of the overall enterprise value, not a lot of debt in this capital structure. Well, that principal shareholder will have to come up with a lot of money based on a one point nine billion dollar average team value. You can do the math where you have to come up with a significant amount of money in the six hundred million dollar range. And so that’s quite interesting, what was an interesting thing that the NFL did in the last year was they eliminated the cross ownership restriction, which now allows them to own a different professional sports team in cities that have an NFL team. Now why that was in place before was that it was viewed that an NFL owner having it and ownership in another professional sports team in another city was actually competing with the NFL.
But in reality, it really doesn’t make sense that an NFL team would be competing for customers dollars with an NHL team. There is sports leagues, so they don’t really overlap and it just doesn’t really make logical sense. And why they did this, this will allow, for example, Stan Kroenke. The owner of the L.A. Rams. Well, he had actually circumvented this rule and transferred his ownership of the Colorado Avalanche in the NHL and the Denver Nuggets in the NBA over to his family members in a trust just to get around this rule. It really did not actually affect any owners in buying the teams that they wanted. What it did was they just found ways to circumvent the rules. And really all this is about any of these changes are all about creating more liquidity for when owners do want to sell. The other thing that I would like to point out is that sales of LP Steaks is that all the headlines that are big premiums to a Forbes valuation are for majority stakes. What go for typically a discounted rate, typically 10 to 25 percent are the limited partners or minority stakes, which are for significantly less. You really don’t have much of a say of how the organization is run. The best description I have seen is the people who pay the most for the best seats.
Julian Klymochko: Right, you get to talk with the team and have some control over what is happening. Meanwhile, minority shareholders might get some free tickets, but certainly not floor seats. I just wanted to really, frame this investment opportunity for investors. You mentioned the 12 percent annual returns, and if you think you know, what does that equate to, it equate to the replicator money doubling every six years. Twelve percent annualized has outperformed the market sort of 8 to 10 percent annual returns. So you are seeing or you have seen better returns than the stock market from professional sports team ownership. Investors, you know, could be pretty keen on this potential opportunity. Nonetheless, it is a regular or relatively speculative asset. Certainly, it consider a trophy asset that comes with a lot of bragging rights and you don’t really get to brag too much about the stocks you own, but you could certainly brag about the ownership interest you have in a professional sports franchise. Not to mention I see a couple of really interesting growth opportunities for professional sports team franchises specifically, and number one would be legalized gambling in the U.S. if that does come to fruition. You can see big upside in revenue opportunities and therefore valuations of professional sports teams. The other thing is media rights with a lot of technology and Internet giants coming into the mix, whether it be Facebook, Amazon, Twitter, Apple, they’re all trying to really establish a solid foothold on media and they are starting to see them bid on certain sports right. As the rights to these events go up, the sports team valuations and revenues go up as well. Presenting further upside for investors here, I think this is an interesting opportunities for investors to go along as it could be an attractive investment opportunities. So keep your eyes on this potential NBA team ownership opportunity.
And that’s it, folks, for episode 30 of The Absolute Return Podcast, if you liked it, you can check out more episodes on absolutereturnpodcast.com leave us a rating if you’re up for it and we will chat with you next week. Hope you have a good one, cheers.
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