March 18, 2019– Barrick & Newmont joint venture: Was Barrick’s hostile bid just a ploy?

Oaktree goes BAM. Did Howard Marks just call a market top?

Boeing 737 aircraft suffers tragic crash. What are the implications?

HEXO acquires Newstrike in $260 million deal. More to come?

No hard Brexit. Does anyone know what’s going on?

Discussion: 52-week high investing

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Transcript

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 ladies and gents to episode 5 of the absolute return podcast. I’m your host Julian Klymochko.

Mike: And I’m Mike Kesslering.

Julian: In this week’s episode we’re going to chat about 52-week high investing and Brexit, what’s going on with that, does anyone really know? Hexo acquires a Newstrike in a 260-million-dollar deal in the cannabis space. Is there more to come? Boeing 737 aircraft suffered a tragic crash and we’re going to discuss some of the implications. Oaktree goes to Brookfield asset management. What does that deal mean and did Howard Marks just call a market top? Finally, more discussion of the Barrick and Newmont drama.

Okay so let’s get to it the first thing up to that is the Barrick and Newmont news. As we previously discussed on last week’s podcast Barrick ended up dropping its hostile bid in favor of a friendly joint venture agreement for the Nevada assets between the two companies and so the scenario that we called and that we viewed as most likely and it kind of  proves out our theory that I believe Barrick’s hostile bid, with no premium and all stock, and so very unrealistic. It was likely just a ploy to create some drama and get Newmont to the table in terms of discussions for this deal. What are your thoughts on it?

Mike: Yeah it was something that we had mentioned was the basically the delta in ownership that Barrick would have in the joint venture which Barrick thought that they should have 63 percent, Newmont thought 55 percent. What ended up coming into the actual deal was that Barrick would hold a sixty-one-point five percent ownership. So right you know in between those two.

Julian: Yeah so this was a deal that shareholders really wanted. The joint venture as opposed to just getting bigger for the sake of getting bigger and there’s real value here. If we talk about synergies, or cost savings, the companies estimate synergies of 500 million dollars per year through the joint-venture and so that is a total value of 4.7 billion in total savings that goes right to the bottom line. So, shareholders have got to be happy with that.

Mike: And you’ll recall that Barrick actually estimated the total synergies of a merger were around 750 million. So about two-thirds of that lied in the Nevada assets.

Julian: Yeah and ultimately synergies are highly speculative and typically don’t happen. So, I guess we’ll monitor the situation and see what happens next. But ultimately this situation seems resolved. The hostile bid is good and dead. We got a friendly deal between these two in the form of a joint venture, so everyone should be happy. Also note that the Goldcorp deal by Newmont is likely to go ahead as well.

Mike: One other aspect of the new Newmont Goldcorp deal is that it actually opens the door for joint ventures between Goldcorp and Barrick.

Julian: Yeah makes sense, we’ll see what happens here.

Some M&A news – Brookfield Asset Management is buying a controlling stake in distressed debt specialist Oaktree Capital in a 4.7 billion-dollar deal. So what Brookfield is doing they’re pretty strong in asset management with respect to real estate, infrastructure and private equity. So, they’re effectively expanding into an additional asset class, that being distressed debt. In which what they didn’t really have the expertise. But Oaktree really is a specialist here. Oaktree with 120 billion in assets under management. Once the deal closes this will bring Brookfield to a five hundred billion in assets under management. So truly one of the leaders if not be number one in the alternative asset management space certainly up there with Blackstone, Carlyle, KKR and those groups. Stuff specific on the deal it was a pretty slim premium 12.4% over the market price, cash and share bid. For now, they’re just taking out the public shareholders. The remainder is going to be owned by employees, specifically co-chairman Bruce Karsch and Howard Marks. They will maintain operating control and obviously a significant portion of the business and so for now oak tree will be independent and operated independently and one thing I wanted to chat about is Howard Marks literally wrote the book on mastering the market cycle, in fact that’s exactly what his book was called. So, I think it’s notable – he’s really known for making really good cyclical bets. Prior to 2008 they were selling a lot of assets and raising cash, so they could really capitalize during the global financial crisis and buy a lot of assets on the cheap and have really well performing funds from the bottom of that recession there and so when Howard marks is selling, does that indicate the top of the cycle here from the quote master of the market cycle himself? What are your thoughts?

Mike: Yeah, it’s something to consider. I mean what it really looks like is that this is just an organized succession plan for the Oaktree founders. Starting in the year 2022 until 2029 they’ll be able to sell their shares directly to Brookfield, which will ultimately result in Brookfield having the ability to have 100% ownership. The other aspect that you mentioned was that this expands Brookfield’s credit platform and so just like to note that 76% of Oaktree’s AUM is credit based.

Julian: And Howard Marks certainly not a young guy, a veteran. Been in the business for a long time. I believe he’s mid-70s. So, it looks like a retirement play for him. But note the timing of this sale and his expertise in market cycles. So, I would take that with you know a little bit of caution on where we are with respect to the market cycle.

Boeing 737 aircraft crashes tragically killing all hundred and fifty-seven passengers on board. Now this is a tough story, obviously thoughts and prayers to all the families of the victims, the crash victims and just a really sad story. What happened was Ethiopian airlines Boeing 737 max 8, it crashed without any survivors and this was actually the second time this model of aircraft is fatally crashed in the last five months. So clearly regulators and market participants thinking that there’s something wrong with the plane. On the week Boeing stock lost over 10 percent, representing 25 billion in lost market cap. So, people are focused on whether or not there’s a design flaw. A number of countries went on and grounded the aircraft, the 737 and U.S. and Canada followed that up on Wednesday and then in fact the company Boeing itself issued a global alert to ground all of these planes. So, you know a lot of potential reputational damage, a lot of operating issues. But I mean it’s the right move to have to ground these things before they know that there’s some sort of software error. They’re working on upgrading the software. It might be with something with balancing the plane or something of that nature. But certainly, serious market implications, what are your thoughts on this one?

Mike: Yeah so, I believe they announced that they will be providing a software update in the next 10 days. So, we’ll see if they’re able to stick to that timeline. But from a market perspective what’s been interesting is watching the option market is that the in terms of the costs of the put options, you’re seeing the cost of hedging against a further 10 percent decline has actually doubled in the last few days. Which is really just an example of investors buying insurance after an incident.

Julian: Yeah certainly there’s a lot of concern out there by the market. We talked about how meaningful this plane is for Boeing. I mean it is up to two-thirds of future deliveries and 40% of the company’s total profits. So certainly, very material here. They’ve delivered 350 and have total orders of more than 5,000. Major implications here, if there are safety issues discovered and really just a sad story and hopefully Boeing can fix this asap, so these issues no longer happen.

Mike: And then in terms of the second-order effects is what you’re seeing is that Air Canada has actually suspended their financial guidance for 2019 as they do have 24, 737s and they were due to take another delivery of another 18 in 2019. So that puts a lot of their financial well-being in the balance in the future here.

Julian: Certainly, far-ranging implications here and a lot of market disruption for nearly everyone involved in the aviation industry. So, we’ll keep an eye on this one, see how it plays out. But hopefully you know the worst of this is over and companies can recover from this, which I’m sure they will.

A lot of news in the cannabis space this week, we’ll start out with some consolidation some M&A; news with Hexo acquiring Newstrike Brands in a 260 million all stock deal. So, what this does is it makes Hexo quite a bit larger now they’re going to rank in the top 5 of Canadian cannabis producers, which includes companies such as Canopy Growth, Aphria, Aurora, Tilray. So, another big deal we can expect a lot more consolidation in the industry. You don’t really need hundreds of licensed producers. It’ll likely end up over many many years looking like tobacco where you have a very small handful of major major players and that’s how things seem to be starting to play out here. What do you think about it?

Mike: Yeah so Hexo they have a really large footprint in Quebec. But this will actually really increase their distribution print from three to eight provinces, which is a positive. The other aspect that I was looking at was their relatively low premium at the time of the deal only around 4% and near Newstrike’s 52-week low. Which is kind of interesting and could leave the door open for a competing bid. Now there is lockups in support of the merger for about 25% of the ownership base. So, a competing bid would likely have to go hostile since the board is in support of this bid. But what are your thoughts on the possibility of a hostile bid?

Julian: Yeah, it’s always a possibility when a company is in play like in Newstrike is at the moment. So, we’ll see if anyone steps up. Like I say a lot of consolidation in this industry, a decent number of players really driving the deals here. Whether it be Canopy, Aurora, Aphria really trying to consolidate. They all want that, it’s kind of ego driven to be the number one producer, the number one market capitalization, they’re all aiming for that number one spot. So, we’ll see. I don’t think there’s any truly unique assets here. I know that Newstrike does have a marketing deal with the tragically hip the you know famous Canadian band. But is that really a unique asset? I doubt that anyone steps up. But sometimes these things are a surprise. So, if you’re a Newstrike is shareholder likely find some synergies in this deal such that they could create value in the combined entity and see where things go from there.

Mike: It does actually improve their balance sheet a little bit bringing their net cash position up by about fifty million dollars in the acquisition, since it was just an all paper deal.

Julian: Yes, deal could make sense.

And additional cannabis news, a really surprising press release out of Aurora Cannabis appointing Nelson Peltz as a strategic advisor. Now Nelson Peltz is a really famous, at least in the hedge fund world activist, investor out of the U.S.  A fairly old gentleman, what is he in his mid to late 70s? So, he’s CEO and founder of Trian Fund Management; a multi-billion-dollar hedge fund. He’s had a number of notable activist campaigns including Heinz, Mondelez in which he was previously director of both. He is currently chairman of Wendy’s, the restaurant company and director of Procter & Gamble. Some of his latest activist campaigns there’s General Electric. Which you know obviously hasn’t gone very well for him. There’s also Procter & Gamble of which he successfully campaigned for a board seat. So, his background is largely in these American large classic companies that have been around for decades and decades, if not hundreds of years. Names like GE, Kraft, Wendy’s. So, to see him get involved in Aurora Cannabis it’s just somewhat of a head-scratcher. But in my opinion a huge win for Aurora given his connections to many of these consumer large consumer brands in the U.S.

Mike: Yeah and in terms of the consumer brands I think that’s exactly it. That’s what they’re looking for is a way to get partnerships with some of these reputable consumer packaged goods.  One of the other activist campaigns that he had launched was with PepsiCo as well. So, there’s plenty of strategic partnerships that he could possibly add value on and then on his side he actually hasn’t had to put up any capital. So, he’s just being issued these options. I believe it was 20 million, options to purchase 20 million shares at $10.34 for the next three or three or four years actually and that those options would represent around 2% of Aurora shares outstanding. So, if he is able to you know negotiate a partnership with a CPG company, this could look like bargain in terms the compensation being given to him.

Julian: He has a good chance of creating a lot of shareholder value at Aurora and being the finance nerd that I am I just had to calculate the value of his options package. So, I calculated a hundred and fifty million dollars in value from Aurora to Nelson Peltz here in the form of fairly sizable options package. So, we’ll see if that ends up paying off for the company.

Mike: Yeah, the other aspect that I didn’t mention was that this could add perhaps focus the company less on production growth and more on returns focus. So, focusing on ROIC as opposed to just growing production.

Julian: Certainly, he is a champion of shareholder governance, good corporate governance and value creation from a shareholder perspective. So, it’s worthwhile monitoring him and I think if you’re in an Aurora shareholder that you got to be pretty happy with that. Despite the fairly sizeable dilution.

And lastly, I can’t help but comment on this Wall Street Journal article regarding cannabis drinks. The main point of the article is that they in fact taste terrible. Many companies trying to develop THC beverages and some of the early feedback from consumers is quote oily grass flavors, with notes of dish soap and urine. So, these cannabis extracts they don’t mix well with water and these drinks not only do they not taste good, but they need to be shaken frequently. So, you know making you work as a drinker not just that, but they also take quite a while to feel that THC, the effects of the cannabis. Could be even longer than an hour. So certainly, some growing pains here with respect to attacking this potential massive new market and I could just imagine the sheer terror of the employees of these different companies and these product groups when they’re getting this feedback that would be a very interesting feedback to receive. Another thing today is that one of the companies that we just mentioned, Hexo; they actually do have a partnership with Molson Coors. So hopefully they’re able to be more successful.

Yeah, I think this will ultimately be figured out. It’s just how long will it take and what’s the end result but. A lot of money being thrown at this segment, a lot of hopes and dreams, so we’ll see how it turns out.

UK MPs vote to reject a no deal Brexit. So, they actually voted is pretty close 312 to 308 to reject the scenario on which the UK wouldn’t leave the EU, no trade agreements. Also known as a hard Brexit. You’ve probably been hearing that terminology constantly ever since they had the referendum in June 2016 and the timeframe since that happened has been a lot of news with really no action. There was in fact a Brexit deadline of March 29th this month at the end of this month in which they were supposedly or supposed to have a deal to exit the European union either on a friendly basis with a number of trade agreements or on you know emergency basis really with no backstop. But it looks like that will ultimately be delayed and if you think about it, no one really knows what’s going on here it. Just seems to be an unmitigated disaster. Obviously, Brexit is just completely unnecessary. It’s horrible for the UK economy, it’s horrible for the currency, awful for the stock market. Ultimately, I think, and I hope that they just scrap the whole thing and just forget about it. Realize it was a mistake. Initial referendum was way too close. Both sides were nearly at 50/50. Now I think the leave vote are really starting to realize or have realized over the past number of years that this is just was a horrible decision and I think that they really regret it.

Mike: Yeah and so in terms of the implications for European investors, those have been discussed in great detail over the last couple of years. But what are some of the second-order effects for the north American investors?

Julian: I think it mostly depends if companies are invested in have operations in the UK and there’s currency issues as well. Obviously if they scrap Brexit, I believe that the pound would rally the UK economy would do quite a bit better. But if they do, if they do have hard Brexit, I mean you can likely expect a recession in the UK and a lot of companies looking to leave. So, it’s more so if you are candidate of the U.S., not a big deal. You probably annoyed by it now as all of us, takes up time and our reading schedule. But nonetheless if you are a European it is an important issue and so we hope like we think nearly everyone that this whole thing just gets ultimately scrapped and we can all just walk away and forget about it.

Mike: And remove the uncertainty.

Julian: Had a couple questions on our blog post this week, it was called playing both offense and defense with factor investing. Now this specific post noted it was really regarding momentum investing in a specific strategy. Within the momentum factor it’s called the 52-week high anomaly and what this strategy entails is you want to go long stocks closest to the 52 weeks are high. The highest price that stock is reached in the past year and go short stocks furthest away from their 52-week high. So, you’re effectively betting on stocks that are going up to continue going up capitalizing on that momentum and conversely betting against stocks that have been going down, depending that they will continue to go down. So, a strategy that you know has produced some pretty spectacular results historically. I’ve got the numbers in front of me now it’s also in a blog post. The long portfolio of stocks near their 52-week in the top 10% or top decile, compounded at 16% annually and that’s over 20 years. So, if you invested on the $100,000 in that portfolio, you’d have approximately 2 million dollars. Now if we look at the bottom 10%, the worst momentum stocks in that basket of Canadian securities. A $100,000 investment would have suffered a 90% loss. Some substantial divergence there and I wanted to talk about how factors are implemented within ETFs. Because you’re probably hearing a lot about a momentum ETF, a value ETF, quality ETF and those are all specific factors and the way that factors were meant to be implemented is on a long short basis. Where your long top decile or whatever you know quantile, it is and then short the bottom. Betting against the bottom, a true alpha creator where you are market neutral or hedged against any market beta any sort of market effects and that’s historically how it was written about in the financial research, the academic research that discovered these factors. But in reality, how they’ve been implemented specifically in the ETF form is on a long only basis. So, I indicated look they’re actually only utilizing factors half assed. What do you think about it?

Mike: Yeah so why are these smart beta strategies? Why are they only going half-assed?

Julian: Well most investors invest on a long only basis and what these ETF manufacturers are doing are really offering what I call value tilts. Not true factor investing, but they are more so offering index investors, people who want to be long the market. The ability to do slightly better than the market by you know tilting these, tilting their portfolios in favor of specific factors on the long side. Obviously long-short investing is for more sophisticated investors. There’s another hurdle there and in just the understanding of how hedging and hedge funds work and short selling. So that’s certainly a barrier and I believe there are some regulatory issues as well. But on the short selling side it certainly is a very unique skill. You can’t just be a long only investor and start implementing short sales. It definitely requires skill, training, practice. There’s a number of unique aspects in running a short portfolio. Such as you know managing your borrow, managing borrow rates, managing risk. So, it’s quite a different beast from long only investing and a lot of the long only players just haven’t really picked up those skills.

Mike: Yeah so in the evolution of overall you know quantitative investing, do you see this as smart beta is just kind of a middle ground on the way to a more long-term shift to that systemic investing that you just described?

Julian: I think smart beta products make sense. They are akin to long only index investing with value tilts. Which does make sense. I mean I think you can outperform say the S&P 500 if you tilt it towards value or tilt it towards momentum. So, they do add value in investors’ portfolios. They can be put together very cheaply. You know you’re nearing the fee level of just the S&P 500 index funds. So, if he’s really come down and if you want to run a long short hedge strategy, ultimately that will provide a different risk return profile. That would be you know true factor investing, which is different than smart beta. So, I ultimately think that both methodologies can play an important part in investors’ portfolios.

And that about wraps it up ladies and gents – Episode 5 of the Absolute Return Podcast hope you enjoyed it. As always send us some questions, leave us a review and tune in for next time, cheers.

Thanks for tuning in to the Absolute Return Podcast. This episode was brought to you by accelerate financial technologies. Accelerate, because performance matters. Find out more at www.AccelerateShares.com. The views expressed in this podcast to the personal views of the participants and do not reflect the views of Accelerate. No aspect of this podcast constitutes investment legal or tax advice. Opinions expressed in this podcast should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information and opinions in this podcast are based on current market conditions and may fluctuate and change in the future. No representation or warranty expressed or implied is made on behalf of Accelerate as to the accuracy or completeness of the information contained in this podcast. Accelerate does not accept any liability for any direct indirect or consequential loss or damage suffered by any person as a result relying on all or any part of this podcast and any liability is expressly disclaimed.

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