June 22, 2020—High-Flying German FinTech Wirecard Crashes Amidst Allegations of Fraud. What Should Investors do if they are Long?

SPAC Tortoise Acquisition Speeds Ahead as it Announces Merger with Hyliion. Why Did the Stock Surge?

Royalty Pharma Stock Dazzles in its Debut as the Largest IPO of the Year. Why Were Investors so Keen to Buy?

A Discussion on How to Vaccinate your Investment Portfolio with Arbitrage

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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 podcast listeners to episode 73 of The Absolute Return Podcast. I am Julian Klymochho. 

Michael Kesslering: And I am Mike Kesslering. 

Julian Klymochko: Today is June 19, 2020, a lovely Friday. We had a pretty chill market this week, nothing too crazy going on. Volatility, certainly starting to slow down, no wild moves like we had last week. 

    • But some notable events, including a classic of fraud that could be as larger as comparable to that of famous cases, such as Enron and WorldCom. This one coming from across the pond in Europe, it is Wirecard. So in a move that shocked the market German payments company Wirecard announced that their auditors could not find $2 billion of cash. So there’s these allegations of fraud. What should investors do? If they are long a stock that is accused of fraud.
    • We are going to chat about some SPAC. That is right. Special purpose acquisition companies. One of them, Tortoise Acquisition Corp. They sped ahead, as it announced their merger with an interesting company, private company called Hyliion. Why did Tortoise stock surge as much as 60% on the deal announcement?
    • In IPO, land Royalty Pharma stock dazzled in its debut as the largest IPO of the year. Why were investors so keen to buy this initial public offering? 
    • Then we are going to finish off the podcast on a discussion how to vaccinate your investment portfolio with arbitrage, which is really, really cool.


Julian Klymochko: But first off, let’s touch on this massive fraud. Which is, you know, going to be one of the biggest news stories of the year. As I indicated, German payments company Wirecard, announced that its auditors at EY could not account for $2 billion of cash on its balance sheet prompting allegations of a history of financial fraud at the company. Now this missing cash of $2 billion is basically equivalent to the company’s profits since 2012.

So eight years of profits were basically just made up. Clearly, what was happening here was if the money is not there, cash on the balance sheet’s not there, they were falsifying revenue, falsifying profits, and when you have fake revenue and fake profits, those need to go into the balance sheet somewhere and what they were doing was falsifying the cash balance. So this disappearing cash would supposedly held by two Asian banks, but what sort of blew the lid right open on this potential fraud was these two banks BDO Unibank, and The Bank of Philippine Islands, they said Wirecard was not even a client, so that $2 billion of alleged cash on the balance sheet is non-existent. And that’s kind of the main issue here, but surprisingly, like if you look at the price action and how things have developed over the past 10-12 years, Wirecard had been a stock market darling since basically 2008. It continued a long climb to a huge valuation above $25 billion dollars. Now that 25 billion is now completely at risk of blowing, poof. Certainly about 20 billion of it, so far has basically gone away since the stock crashed. Ever since this development was, unearth. And the stock had climbed over the years, despite continued allegations of the counting trickery and corporate malfeasance on behalf of tenacious, short sellers. I mean, short sellers had been all over this stock for at least a dozen years, which makes us absolutely shocking how anyone could be long the stock. Gets crazy, not only the short sellers were onto this one. They sniffed it out a number of different problems with the accounting at Wirecard, so over the past 18 months, The Financial Times, the very reputable media source newspaper, they revealed in a depth probe into accounting irregularities, and forged contracts at Wirecard basically used to inflate revenue at the company.

For example, in January 2019, The FT said a senior executive at Wirecard used forged and backdated contracts to inflate revenue. So I got to give it up for The Financial Times here, reporter Dan McCrum. Just absolutely fantastic reporting on this file, really in the face of a big challenge. I mean, relentless threats on his employment from the company. They went after him; I believe they sued The Financial Times. Thankfully, Financial Times stood behind the reporter and it was A+. Super well done and it is really being exonerated here with the recent developments. Obviously the CEO falling on his sword here, resigning in shame. Stock down over 70% this week on the news that the fraud. Bonds at $0.37 on the dollar looks like this equity may be a donut. However, it is still trading roughly $5 billion market cap, which is a head scratcher. And I mean on this one, we got to call out the sell side analysts here. Man, where they out to lunch on his file?

Like you had clear allegations of fraud for more than a year, and analysts finally downgrade after the stock tanks over 80%. And it looks like it’s going bankrupt. Now that fraud allegations have come to light. So as of Wednesday, this is before allegations of fraud came out. Missing $2 billion, et cetera, 10 out of 25 analysts tracked by Bloomberg recommend buying the stock and the group as a whole saw a 49% upside in Wirecard shares and since then, I mean talk about closing the barn door after the horses have long left. So since then, at least nine analysts have removed the recommendations and three have downgraded the stock to sell. So ladies and gents, I mean key lesson here, listen to short sellers. When there is smoke, there is fire. Never listened to sell side analysts, man, it is not that these guys are necessarily clueless, but their goal or their role is not necessarily to analyse a stock, a company and make a valid recommendation. Their goal is to basically sell stock to clients of the bank. They are there as salespeople and that is their role and never forget that. As for Wirecard, what is next? Well look to be facing a big liquidity crunch and in my opinion, unlikely to survive. What are your thoughts on this? Just what are your thoughts on this file? It is just a very crazy fraud situation. Well done by the short sellers. Well done by the reporters and a lot of people with egg on their faces, Isn’t there.

Michael Kesslering: Yeah, there certainly is and when you say well done by the short sellers, it really depends which vintage of short sellers you are, talking about because since 2008, there has been short seller interest. I believe in 2008 it started with looking at their balance sheet. That was part of the main theme short thesis at that time but what I find especially disturbing and why you think our listeners, what should anger them as well, even though this is a German company. So I haven’t really followed this as closely up until this week. But what’s really disturbing about this story is the repeat pattern since 2008, where short sellers would come at the company with their thesis in 2008. It was focused on the balance sheet and some issues around that and especially their financial reporting that has kind of been the common theme.

They would come out with their negative thesis and then the German or securities regulators buffin. So they would to prosecute these short sellers for market manipulation. Now this happened multiple times, this happened also in 2012 and 2016. This is just absolutely crazy because, you know, just for having a thesis of being negative on the company. Where you can be prosecuted. 

Julian Klymochko: Yeah. 

Michael Kesslering: Yet on the long side, you look at it, you know, high profile stocks like Tesla or Nikola or companies such as those where you can put like, say whit Tesla, you can put a $4,000 price target, and you’ll never be investigated. And what I’m not saying is that you shouldn’t be able to have a lofty price target. There is no issue with that. You should just be able to both because that is how markets are made, especially with the German regulators. Like the egg on their face is, this is an absolute disgrace because they even imposed a two months short selling SPAC, to protect the company from speculators. It is all done in the name of market manipulation and I think it’s absolute trash.

Julian Klymochko: The shorts were doing their job, literally doing their job for them and not only did they ignore them, but they prosecuted them, which was just, you know, a huge failure on their behalf. And I’m sure heads are going to roll over at the German regulator.

Michael Kesslering: Yeah, you know. I don’t even think there was anything necessarily nefarious that the regulators were doing… 

Julian Klymochko: Could be. 

Michael Kesslering: In Germany. Yeah, there very well could be. There certainly can be the door left open for that, but it is just that, mind-set that short selling is market manipulation, where, you know, we’re seeing on with Hertz and multiple other companies that are bankrupt that are being bid up. Well, that technically is market manipulation as well, but I don’t believe that should be illegal. You mentioned as well you know, with The Financial Times, they did a very good job at reporting this. I think a lot of people have been very critical of the media in this present political climate. So I think it is important that we do point out when there is some very good journalism being done. When both the company and regulators are coming at this journalist and not only did the journalist stand by their, their research, but also the financial times. So a big kudos to them and it really just reminds me a lot of basically every fraud I’ve ever seen. That is a public company and even private companies such as Theranos. It is immediately going to regulators as well as really attacking the journalists and short sellers. So you’re really is you had mentioned other red flags, like if a company is coming out a journalist or a short seller, it’s probably pretty warranted of why that company is being critiqued. If you are running a company, your focus should be running the company and if you want to really stick it to bears, I mean, then just run a great operation and that will take care of itself. When I said it at the onslaught of this, that it depends, which vintage you are as a short seller. I mean, if you are a short seller in 2008, you have been blown out of the water. 

Julian Klymochko: Yeah, no kidding.

Michael Kesslering: Or 2016 as well, and had a big run up into 2018. So, you know, timing is very difficult with, short selling, even with something that is genuinely a fraud. 

Julian Klymochko: Yeah, and so some of the lessons learned here, this is really important case study for investors to follow. So number one, short selling is good for the market because they kind of serve as sort of a sheriff. Because if you look at all these frauds and schemes and scams of over the past, you know, recent history of financial markets, it’s not the auditors that discover it, it is not the regulators that discover it, it is not the longs that discovered. A hundred percent of the time, it is the short sellers. They are financially incentivized to discover these things and time and time again, it’s the shorts that are onto at first. And a lot of the time, it’s the shorts that come out with these reports, the fraud is uncovered and it protects future investors from getting caught up in this fraud, whether it’s Enron, WorldCom, Sino-Forest, these companies were constantly raising capital that caused investors to lose a ton of money. So short selling is good when there is smoke there is fire. So I feel long something like this. I mean, you should not have been long. These allegations were in the market for a long time. You should have been warned. You should have sold a long time ago, but I mean.

Michael Kesslering: This was owned in indexes. It was included in indexes as well, so if you are an institution or any sort of passive fund that is tracking one of the major bond indices in Europe, the DAX. Is you have to hold this and so that’s where short sellers just have to be able to do their job, to ensure that companies such as this don’t make their way into indices. It really becomes an issue because it is easy to say, you know, you should not invest in this, but some of these investors unfortunately have exposure, which is kind of outside of their control. 

Julian Klymochko: Yeah, that is a really good point and it really unearths a negative part about passive investing. You know, typically passive investing is looked upon as you know, this great thing because it is so cheap, accessible, easy to use. However, in situations like these, where there is a fraudulent company and, the firms buying, I mean. If you are a passive buyer, you don’t do any due diligence, right? So buying with no due diligence, that is problematic. And we’re seeing the result of that we’re index investors get absolutely hosed. So who looks good here? Well, certainly short sellers look great and really exonerated here. Financial Times just exceptional reporting on their behalf. Lot of people look bad here. I mean, the company, the CEO, you know, is there an orange jumpsuit in his future, perhaps. Ernst Young, the auditor not looking too good. Long investors, I mean if you’re long this stock at this point, it still has a 5 billion market cap. So if you’re still long sell as quickly as possible before it goes to zero, Mike as you said, regulator looks awful here for not just ignoring the fraud for a very long time when there’s clear signs of something nefarious going on. But in fact, prosecuting the people that were actually doing their job here, sell side analysts, just an embarrassment, and then even passive investing is really taking a hit on this one. So Wirecard, certainly an interesting case study that should be looked at and followed by investors because there’s a lot of different learning aspects to it, but that’s it for now on that firewall certainly continue to follow developments on Wirecard. 


Julian Klymochko: And moving on to some SPAC action this week. Tortoise Acquisition Corp, a special purpose acquisition company, so its stock soar as much as 60% today after it announce a business combination this morning with Hyliion. Hyliion is a leader in electrified powertrain solutions for semi-trucks. Now investors continue to be keen on any stock involved with the electric vehicle market. If you look at Tesla, you know, recently hit a thousand dollars per share and became the largest auto manufacturer on the planet in terms of market capitalization, while only manufacturing, a small fraction of the total automobiles. So Tesla trading at an absolutely insane valuation and then Nikola, which was another recent SPAC deal. What is that stock up? 500% since that deal got announced, so investors more so unsophisticated, speculative investors enamoured with anything to do with electric vehicles. And it looks like Tortoise Acquisition- Hyliion is no different stock as much as 60% up this morning. Did settle around 40%, which is still a quite the impressive gain and it really lends credence to a key strategy that we run within our accelerated arbitrage fund, which is to buy pre deals, special purpose acquisition company SPAC before they announce a deal.

Because from that point you can earn a good baseline, yield roughly 1 to 2% because it trades at a discount to then asset value. And all they have, all they own is, a short term treasury. So they’re earning some income. So it is kind of like a bond to play, but with its wicked equity upside, as we saw on Tortoise today, rising as much as 60%. So if a SPAC announces a deal that the market likes you can exit at a huge gain. So we like the risk reward profile, you get the downside or basically no downside similar to that of treasuries and really good equity upside, especially in the current environment. So that’s really where we’re focusing our efforts. I call them Q1 vintage SPAC IPOs that were announced in Q1 of 2019 that have not announced a deal yet such as Tortoise. Those ones are likely to announce a deal soon and as we can see from the price action on this one on others as well, where the market is really becoming keen on post deal SPAC, bidding them up. So there’s this tremendous upside optionality, which our thesis is such that it’s not being properly priced into the market with many of these SPAC still at discounts to NAV. What are your thoughts on this deal here? This Tortoise Acquisition, Hyliion, perhaps the next Nikola. What do you think?

Michael Kesslering: Yeah, I mean, I will admit that some aspects of just, you know, reading well with, their business. There are some interesting aspects of their business. Comparing it to Nikola and comparing it to Tesla. When you look at Tesla and how they manufacture. They do everything in house with the exception of their, of their batteries, which are outsourced to Panasonic. Whereas Hyliion would be looking to outsource all of their manufacturing, going with more of an asset light business model that they believe can get them higher margins. It is interesting to see a few different business models out there in the electrified car space. However, all of that is pure speculation. I have seen some of the analysis that was actually making a little bit of a play that Hyliion. That their valuation was reasonable and maybe even a value plate given its 2024 EBITDA multiple versus Nikola.

And all I have to say it to that is just, wow. I mean, if you can forecast their EBITDA within $50 million to a $100 million. If you can forecast it within a delta of that in 2024, then props to you because I just don’t see how, like, especially in a startup like this. We are going to have any read through; even reading through in a more mature company in 2024 is quite difficult. Never mind something that is out a very much an inflection point where I think this could have a very binary outcome, either. It absolutely explodes its business model works out very well, or it is a zero. I think it is quite binary, to play it off as a value play for on their 2024, multiple was pretty crazy and that’s coming from a background in investment banking when you would be looking at some very creative multiples to value one of your clients on. That one even made me chuckle quite a bit, but that is about all I have on this one. 

Julian Klymochko: Yeah, certainly some creative financial acrobatics to justify the extremely lofty valuation here. I mean, 40% premium after one day, certainly would not recommend getting involved in these post deal SPAC that are trading at a huge premium to net asset value. The way to play it as you get in pre deal, then it pops and then you exit. And I joked that this seems to be a big wealth transfer from hedge funds who buy the IPOs on the SPAC and hold them, and then exit to unsophisticated speculators who like it much more when it goes up 50% after the deal gets announced. So it’s interesting dynamic that who knows how long it’ll last in the market, but we are certainly looking to capitalize on that interest and upside optionality in the pre deal SPAC market. 


Julian Klymochko: Now to have M&A news. I wanted to highlight at the initial public offering of Royalty Pharma because it really shows that hot initial public offerings, hot IPO are back baby. Royalty Pharma surged over 57% in it’s NASDAQ debut this week. It sold shares in the IPO at 28 bucks; a share raised about 2.2 billion. Now that made it the largest IPO of 2020 edging out Warner Music IPO earlier this month. And this is also the second largest form of IPO of all time. Now, this is nice to see the bulk of the money raised is going towards the company, which will use the cash to acquire more royalty rights. What we have been seeing a bit too much, in my opinion in the IPO market is that of exits. It is either a venture capital exit, private equity exit, or for Warner music. It was Blavatnik exiting the stock. So they’re basically looking to put lipstick on a pig. Time the market such that they can sell their companies to public investors at the right time at the highest valuation possible. And, you know, it’s kind of disturbing to see that because the public markets shouldn’t be known as a dumping ground for VCs and PE firms to basically flip their junk on once they’re done with it.

It is nice to see an actually growing company, Royalty Pharma, raising capital for growth initiatives, which is really what an IPO should be used for not flipping it to pension funds and, and retail investors. But this deal was super-hot, it was 10 times oversubscribed. Demand of more than 20 billion for a $2.2 billion deal. And with demand like that, when it’s that oversubscribed, of course, that’s a complete for explosive stock gains cause so many people want to get into this deal. And its first few days of trading, the shares jumped from 28 bucks to over 50 valuing the ferment, nearly $30 billion. Now this IPO of Royalty Pharma, it is different than many of the other IPOs we saw recently in the healthcare space. Which were all quite speculative, biotech deals. Royalty Pharma is more of a cash flow play less of a high growth speculative stock because Royalty just as you can imagine, it acquires royalties of future drugs from labs and smaller biotech companies.

And that’s sort of the circle of life is that these labs that biotech companies use that monetization use that cash to continue to fund their research. So Royalty Pharma, more of a cash flow generator, as opposed to you know, a research company that will create some of these new treatments, but been around since 1996. So really stable you know, large company now, now its $30 billion. So it’s really nice to see the market healing and being open, not just open, but this IPO window is wide open. Seeing stock up nearly up 66, 0% on its first day of trading. What are your thoughts on this Royalty Pharma deal?

Michael Kesslering: Yeah, it is certainly interesting deal. And the way I like to think about it is, you know, that this is really like for Pablo LeGorreta, it really is just a permanent capital vehicle for him and like this, you know, you mentioned that it’s all cash flow based and really, it’s just an investment fund is, is really what it is. Where his private investment company will still, they still have a management contract with this. So it still works out quite well for him where they will still be paid 1% of the assets overseas annually, plus a 6.5% performance fee. So you know, a very good stream for his own private company as well. And I wouldn’t note, I believe that’s 1% of the assets, not just the net assets. I am not entirely sure how levered the company is, but that is interesting to note is typically when you would look at a fund. Typically, hedge fund or private equity fund is that they would be taking their management fee off, of the net assets.

But I believe they’re taking it just off of the total assets but as well, just a little background on LeGorreta. He is a former investment banker kind of thought of as one of the pioneers in investing in the Pharma royalty stream space and the royalty stream space really is for Canadian investors. There is quite a few examples, both in metals and mining is where they are quite popular as well as there is a few in energy as well. There is a few vehicles in Canada that are quite popular with Canadian dividend investors. But typically all work, they buy stream that would range from 1.5% to 18% of a specific drug sales and I believe they quoted in their S1 that they really haven’t sold any of their streams. So they’ve acquired these streams and they’re really a long-term holders. Think of kind of like a Warren Buffet- Berkshire Hathaway except they are not buying full companies. They are just buying streams in individual drugs. You had mentioned as well, that they are really positive thing being that the majority of this wasn’t just the cash out existing investors. Now by my math, I believe it was 22% of the IPO went to buy out some of the existing investors and keep in mind, this is the first major liquidity event since 1996, so they have certainly been long-term investors and you know, some of them wanting to get out. That is kind of understandable.

Julian Klymochko: Certainly after 25 years. 

Michael Kesslering: Exactly. Yeah and the remainder will be used to finance, buy more royalties basically. But yeah, this was a, certainly an interesting one. It’s been a little bit you know, a little bit of a bizarr world in IPO is the last year, a lot of, of the ones that we’ve looked at you know, the business model just wasn’t that compelling. So it’s really nice to see this one, were not a little bit about a very interesting business model.

Julian Klymochko: Yeah, exactly and certainly indicative of the normalizing environment in the markets, investors welcoming to this type of deal, a Royalty Pharma deal. And I think next week we can expect an IPO from Albertson the grocery company, which is something to look forward to as well. That is a private equity exit and I have a lot to say about that one, you better believe it. 


Julian Klymochko: But I also put out a blog post this week on how to vaccinate your investment portfolio with arbitrage. And what we do at Accelerate, so we have a SPAC index, which basically tracks the performance of all. I think there is about 104 blind tech companies listed in the U.S. and we have created an index out of that. And we compared the performance of this special purpose acquisition company index versus the global bond portfolio and what we noticed, and we wanted to study year to date basically started the year to end of May because it was an extremely volatile period.

And a lot of investors were stuck, you know, scratching their heads. What can they do to sort of eliminate some of that risk and volatility within their portfolio? Because even the global bond portfolio, as indicated by the Bloomberg Barclays Global Aggregate Bond Index and a peak drawdown of nearly 9% in the first quarter and year to date through may it returned just over 2% with a volatility of nearly 8%. So a very, very volatile more than investors should be used to there. Now over the same timeframe, the SPAC index returned 3.8%. So nearly doubled that return with the volatility of just 5.3% and a peak draw down of just 6.6%. So not only significantly better performance for SPAC as compared to bonds, but they did it with significantly less volatility and a much lower draw down. That’s right, outperformance of 170 basis points of SPAC compared with bonds, but doing it with 31% less volatility and a 25% lower draw down.

I also ran some other numbers on the SPAC index correlations between bonds and stocks. So the key to diversifying one’s portfolio is to find assets that either have low correlation, no correlation or negative correlation, because the more of those you can put within a portfolio, the better ultimately the risk adjusted returns, because they say that diversification is the only free lunch in investing. But if you think you’re diversifying with a bunch of correlated, highly correlated assets, that’s not going to work. You want assets that are uncorrelated or perhaps even negative correlated. Now over this time period, year to date 2020 SPAC have had a correlation with bonds of negative 0.37. And the correlation with stocks, the S&P 500 of negative point 58. So that ladies and gents is something that we like to see in our portfolios from a diversification perspective. So if you’re looking to vaccinate our portfolio, check out arbitrage, I mean, SPACs are performing very well lately. We really liked the asset class and that is why we do own them in our arbitrage fund. And that basically summarizes all I’ve got to say this week, so we really hope you enjoyed the episode today. If you liked it, you can check out more at absolutereturnpodcast.com. So definitely follow me on Twitter. The people’s hedge fund manager, my handle is @Julian Klymochko and Mike where can they find you on the old Twitter machine?

Michael Kesslering: Is M_Kesselering, and I will have to think of a creative tagline to compete with the people’s hedge fund manager. 

Julian Klymochko: Yeah. 

Michael Kesslering: Really got to compete with that. 

Julian Klymochko: I may have to be changing mine to the SPAC man, soon if we cover these, so we will have to see about that. But listeners, we wish you all the best in your investing, trading and speculating this week and we will chat with you soon. 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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