July 13, 2020—Warren Buffett Finally Makes a Move as Berkshire Strikes $10 Billion Deal. Does this Acquisition Signal that Buffett is Anti-ESG?

Chinese Stocks Enter into Bubble Territory After State-Directed Speculative Rally. Is the Stock Surge Justified?

Rival Investor Group Emerges With Higher Bid for Torstar. Is this the Start of a Bidding War?

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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 76 of The Absolute Return Podcast. I am Julian Klymochko

Michael Kesslering: And I’m Mike Kesslering.

Julian Klymochko: Today is lovely Thursday, July 9, 2020. Not recording this on a Friday as usual because tomorrow we have our second annual Calgary Stampede Party, right. The Accelerate Party.

Michael Kesslering: Yeah, it is exciting. It should be a good time. Obviously, we don’t have the stampede this year, but it will still be good to enjoy it with some of our investors.

Julian Klymochko: Yeah, it is great to have investors and clients out to celebrate, have some food and drinks on a nice Friday afternoon. And the other thing is you look at what’s happening in the U.S. and coronavirus cases are just out of control. They now have over 60,000 per day, over 3 million cases in the U.S. and some cities have tens of thousands or hundreds of thousands of ongoing cases. I think the number of people sick right now are like 2 million in the U.S. and in Canada, we are a completely different environment with about 300 new cases per day, and roughly 30,000 people who are currently infected and a city like Calgary. I think there is about you know, maybe 40 per day and about 200 and something that are currently infected with COVID-19. So it is great to be able to get out there and live a normal life and have drinks with friends and colleagues and things of that nature.

So hopefully in the U.S. anyone from there listening, man, where your masks. It is a great idea and let’s get through this. Mask is not all that bad, do your social distancing and then we will all get our freedoms back, but I digress, let’s get into the action this week.

    • And something really, really important happened this week. Something that I have been waiting a damn long time to see, and Warren Buffett, the greatest investor of all time. Finally made a move as Berkshire Hathaway struck a $10 billion deal. Does this acquisition signal that buffet is anti ESG? That is right. This deal involved natural resources. And is an interesting swap in the environmental, social and government governance angle.
    • Then we wanted to chat about what is happening in Chinese stocks. They entered into bubble territory this week after the state directed media and government basically ignited the speculative rally. Is this stock surge justified?
    • Lastly, we are bringing up a file that we talked out a couple of months ago. This is the Torstar bid; it is an M&A situation. A rival investor group emerged with a higher bid. If you had known, if you are a long-term podcast listener. Torstar was the company being taken over for a negative enterprise value. So we’re not to see a higher bid come for this one. We are going to chat about, is this going to start a bidding war?


Julian Klymochko: But first let’s touch on this big Warren Buffett deal. Finally got out the elephant gun, stepped up to the plate and swung, but this is not one of those elephant sized deals he was looking for. As you recall, Berkshire has over 130 billion in cash, and this was just a $10 billion deal of which they paid 4 billion in cash and assumed roughly 6 billion of debt.

So I wouldn’t classify it as one of these elephants he’s been hunting for, but perhaps more like a deer or a gazelle kind of you know, could provide something nice to put on the wall and maybe some good meals or something, but this deal. Berkshire Hathaway announced the acquisition of Dominion Energy’s natural gas assets for $10 Bilski. That is right. They are getting, for this cash, 7,700 miles of pipelines, 900 billion cubic feet of natural gas storage, and other natural gas infrastructure. Kind of like a drop in the bucket because Berkshire Hathaway is a massive energy investor on the infrastructure side. So this $10 billion deal just adds to a $100 billion dollar energy segment at Berkshire. It gives the company additional heft in the growing natural gas industry, which roughly doubles its market share in natural gas distribution. Good valuation on this one, 10 times EBITDA. Buffett’s always a value investor, no matter what he says, irrespective of focusing on business quality and moat and all those things, it’s kind of nonsense.

Just watch what he does, not what he says, because he’s just buying cheap stocks at 10 times EBITDA. Cheap assets, significantly less than the market, and even less than comps, I believe. In terms of historical acquisitions, this was actually Berkshire’s largest deal in four years. In 2016, they bought Precision Castparts for $37 billion dollars, which was a pretty giant deal at the time. One dynamic that I wanted to touch on with respect to this Berkshire deal was that of ESG. Now ESG refers to investing, taking into account environmental, social, and governance issues. Now that has become super, super hot from a marketing perspective. Many clients, many investors want to invest with an ESG bias. Meanwhile, many investors, fundamental investors, tongue in cheek, they call it ESG “eye roll, sneer, and groan” because some are skeptical. They don’t believe that it leads to better returns.

In fact, if you’re limiting your investment environment, that actually could lead to worse returns over the long term, and really many believe that investors are doing it just to build assets, not trying to maximize returns. Looking for those marketing dollars to see AUM growth. However, if we look at performance of ESC over the say, like the last five years. It has outperformed the market and that is basically just for a couple of basic reasons. Number one, ESG by nature is underweight oil and energy and oil stocks have been the worst sector by far for the past five years and counter balancing that. ESG is super overweight tech and tech has been hot over the last five years, outperforming dramatically. The other thing that I saw comment from BlackRock on ESG, because they made a huge entrance into ESG investing. It is just the momentum as more and more people demand ESG more and more capital floods into that leads to more and more inefficiencies and pricing of securities and ESG stocks. Those that are rated high on a scale of ESG metrics get bid up and bid up. Meanwhile, those ranking low get sold off, such that you get this massive value divergence and this momentum effect on the ESG stocks.

So what I see what is happening here is that Dominion Energy is trying to get blessed with the notion of being an ESG company. They are an energy infrastructure company and their target is to reach net zero emissions by 2050. So divesting their natural gas infrastructure assets to Berkshire certainly makes sense in trying to get into bed with these ESG investors. Now, if you look at the opposite, Berkshire Hathaway is basically taking the anti ESG approach. If we look at how Buffett invests. He his old school, and ironically, I refer to old school as being focused on fundamentals, focused on cash flow and valuing an asset based off a discounted cash flow analysis. (i.e. you know how much cash flow will this asset yield to me per annum?)

And that’s how he values assets, but many market participants in these days with ESG so hot. Fundamentals don’t really matter all that much. A lot of investors and even companies are going for the story and right now ESG makes a great story, and if you have a great story, you do get a premium multiple in the market. Now who knows how long that is going to last of this interesting market environment where fundamentals don’t really matter. Cash flows don’t matter where the market’s rewarding money, losing businesses with no path to profitability, that’s the environment we’re in and it’s gone on longer than most fundamental investors would have thought, but who really knows it can, I guess, theoretically go on forever. However, if you look at the old Ben Graham quote. And the short term, the market’s a voting machine and a long term, it’s a weighing machine. Just referring to the fact that at some point the market and investors are going to go back to valuing assets based off cash flows and not putting nearly as much into, is this a good story? Does this help, with the marketability of my stock or my fund? And, you know, will it help get it to trade higher? Well, it helped me to gain more assets under management and get a better ESG score? So it’s a really interesting trade off where Buffet’s effectively buying the cash flows. Dominion selling this asset at a discount to get that ESG blessing. And it really goes to show where the market’s heading this year and if we look at share price performance, I mean, Berkshire has struggled down about 20% year to date and Dominion Energy, I mean, they are not doing so hot either. On news of the deal, they actually dropped 7%, so investors were not necessarily picking up that ESG vibe of this deal, but nonetheless, great to see as a long-term fan and shareholder of Berkshire Hathaway. Love seeing buffet finally do a deal. I was kind of disappointed seeing him, go through the entire first quarter, the biggest bear markets since 2008, without him doing a deal. So we finally got it done. Mike, what are your thoughts on Berkshire deal here? 10 billion.

Michael Kesslering: Yeah, especially with Buffett. Looking at the pandemic and his lack of action so far. I mean, really just the fed stepped in as the lender of last resort, instead of him being able to step in like in 2008 to make favourable deals where he was able to generate really good returns off of. Instead you had the airlines were able to get money that was in a lot better situation while it was just more favourable terms for them through the fed and government aid, as opposed to going to a private investor such as Buffet.

Julian Klymochko: Yeah, exactly. I think what the coronavirus pandemic did is struggling corporations in which you go back 10 years; Buffet would be their first call. Now he is number two, and who is first? Well Jay Powell. Jay Powell of the Federal Reserve. Right?

Michael Kesslering: Exactly and the government itself as well. The Trump government as well. And so you had two first parties. Those would be the first calls and then Buffet after, and it is just interesting. So it’s just kind of changed the game a little bit, but you do make up a good point though, with regards to ESG. I have seen some interesting tweets recently. I believe Eric Balchunas from Bloomberg had made comments about Berkshire, just being the anti ESG firm as well as Amazon and Netflix would be others that there still is quite a bit of valued. I believe Bloomberg had done some back testing on the anti ESG basket over, I believe it was since 2013 or this was back in late 2019. So as of the end of 2019, I believe it had outperformed the top ESG basket, which was interesting to note.

Julian Klymochko: For sure.

Michael Kesslering: Over that time period now that’s just a seven year time period. So you can get, it would be interesting to see something more long term.

Julian Klymochko: Yeah, I think there is a mutual fund called the “vice fund” and they buy like tobacco and alcohol.

Michael Kesslering: In terms of Buffett, you know, this does not put much of a dented in his cash pile. Looking at proforma Berkshire Energy, that component of their business. I thought it interesting stat that now they will account for 18% of interstate net gas transmission, which is up from 8% prior to the deal, assuming that it closes. A couple other things I did want to touch on first being I did have a question from one of our listeners wondering why we would not be involved as a merger arbitrage fund. Why we would not be involved in a deal like this, where it is an asset sale? And that’s just very simply is just in an asset purchase, there’s no real way to isolate just that value through a trade, and so it really isn’t an arbitrage opportunity, as it would be when there is a whole company being purchased, it is just not very easy to isolate. So that is why it is just not, it’s outside the purview of a merger arb fund. You will get special situations funds that will look at things such as that. They will look at asset purchases or turn arounds, spinoffs, things of that nature that are other corporate events that see an undervalued security basically, but that’s just outside of the realm of a typical merger arb fund.

Now, the last thing that I did want to bring up is that this obviously being in the energy space is a deal that has Greg Abel, the vice chairman of Berkshire non-insurance operations and long-time CEO of Berkshire energy.

Julian Klymochko: And future CEO of Berkshire Hathaway, right.

Michael Kesslering: That is why I was bringing it up, and he also is from Edmonton. A little Canadian flair for Berkshire for us Berkshire junkies. Now that is what I was going to ask. Do you still think he is going to be the successor to Buffett? Because my pick overall which I think is somewhat of a dark horse is Todd Combs. I think he could come on and take over that where Jane and Greg Abel would take over and would continue to oversee the operational companies. Whereas a capital allocator could perhaps take over as CEO. But do you, do you still see Greg Abel as the most likely successor to Buffett?

Julian Klymochko: Yeah, I think that is a good bet. I would probably put it at around 75%, but ultimately only the Berkshire Hathaway board knows. So it will be interesting to find out, hopefully we don’t find out for a long time because, you know, we’re wishing that Warren continue to lead Berkshire Hathaway for quite a while.

Michael Kesslering:  [inaudible comment]

Julian Klymochko: Yeah, 120-year-old Buffett still doing deals, maybe he will hit that elephant at some point, that elephant sized deal that he has been aiming for, for all these years. Interesting stat that Berkshire will own 18% of all natural gas infrastructure. So clearly here, their pot committed to the anti ESG play.


Julian Klymochko: Wanted to touch on Chinese stocks. Now what happened here was bullish commentary came out from China state run media. And clearly their government, a lot of the time it’s just political and it’s posturing. What is happening here is that the government wants to push up equities, want to show that, you know, we are doing great. Our economy is great. You know how Donald Trump always likes to talk about NASDAQ hitting new high, Dow hitting new high, et cetera, while it seems like China taken a page from his playbook, because now the CSI 300, the benchmark stock market index in China, it rose about 10% this week with a massive 6% rally on Monday. It’s currency also rallying its strongest level since March and it’s not based on fundamentals. What we have is the Chinese government desire to project an image of economic strength after the coronavirus, which was born from China; it tanked the entire global economy into recession, one of the worst recessions of all time. It is very interesting timing for China to come out and do this. More evidence of a speculative stock bubble happening.

Margin loans used by investors to find that stock purchases have hit a five-year high and margin loans are just a signal of speculative trading activity as investors are borrowing more and more money to buy trading securities. And I wanted to make this parallel, the current state led bull run. It’s similar to what happened back in 2015, where you had this government mandated stock market rally, and it lasted for a little bit, but it ultimately ended in tears when the stock market index tanked more than 40% from its peak of the 2015 rally. So as they say, history, doesn’t repeat, but it does often rhyme. Interesting stat on the current bull-run. One trillion market cap in equities have been added in a day’s that is 1 trillion out of nowhere. It is just a speculative fervour, in my opinion, not necessarily justified by any sort of fundamentals, clearly Chinese economy still struggling. What do you think of this crazy price action in Chinese stocks?

Michael Kesslering: Yeah and kind of comes back to your initial point with Berkshire. The stock market is not the economy. We like to say get over the long run. There is a pretty high correlation, but especially in the short run, it is not reflective of the economy and it could decouple quite substantially. And if you look at here, I mean, just like year to date, the Shanghai compensated is up almost 15%, which is crazy, right? In the middle of a pandemic and really all those gains, like you had mentioned Julian or since the end of June in really in the last few days. And another thing that you had mentioned, and in 2015, that really was on the state media encouraging stock market ownership and it was really just to mask, like you had said, it’s just a mask, the economic outlook weakening.

But what you’re seeing right now is just a lot of margin being used. Right now, I believe it was, I had seen an estimate, that 12% of the trading volume this month was using margin and that is compared to 8% in June, but then when you look comparing it to the 2015 peak. I believe it was Morgan Stanley. That estimated that margin finance and the margin lending was equivalent to a dollar amount, 4% of the stock market capitalization, China. And if you compare that, that actually compared to 10% at the peak in 2015, so I guess what that says is that.

Julian Klymochko: It got a long way to go.

Michael Kesslering: Yeah, It could effectively double the amount of margin financing in terms of its relation to market capitalization. I believe right now, it is right in absolute dollar amount. It is right at the peak of 2015, but when you look at it on a relative basis to market capitalization still has quite a ways to go. So despite being a bubble, bubbles still do continue, can, I shouldn’t say in absolute terms, but they can continue to increase substantially more than what seems rational at the time. So yeah, it is. Does it look to be a bubble right now, but that does not mean that there is going to be a meaner version anytime soon, necessarily.

Julian Klymochko: That is a good point. We are not necessarily encouraging investors to stay away. Just expressing caution, but in bubbles, those can be great times to make money. Whenever I think of a bubble, I think of the George Soros quote-he is one of the greatest macro traders, if not the greatest macro trader of all time- he said, “When I see a bubble forming, I rush in to buy,” and that is somewhat counterintuitive. Usually people want to be selling bubbles and staying away because it could quickly reverse. But as you indicated, these things tend to gather momentum and go up over time and continue. George Soros, his strategy has tried to get involved in the middle of it and sort of ride it for as long as he can and then sort of exit. But he would rush in to buy. He would add fuel to the fire to keep that momentum going and kind of get out sort of a musical chairs type dynamic there. Obviously, he was phenomenal at doing that, given his historical track record in investing. So certainly, I am not indicating that any trader out there can be George Soros, but keep that in mind as a potential trading strategy. Interesting stock market bubble happening in real time in China. So if you are interested.

Michael Kesslering: Especially if you are going short is to keep that in mind.

Julian Klymochko: Yeah don’t do that.

Michael Kesslering: If you are thinking that, hey, this is a bubble and I am going to short it. Do be prepared that, hey; it could go up another a hundred percent, right?

Julian Klymochko: Oh, man or a thousand percent. I have seen so many bears get slaughtered on. For example, Tesla clearly a bubble stock, a story stock and obviously overvalued, but that has not mattered in 10 years and stock IPO, what around 30 bucks. And now it’s like nearly $1,500 a share I believe. And it continues to go up, so there’s really no cap on where things can go or how irrational things can get or how long it can last. So there’s a famous quote that said the market can remain irrational longer than you can remain solvent. So would definitely encourage investors not to short a bubble because that is a great way to quickly go broke.


Julian Klymochko: Wanted to finish up on a really interesting M&A situation that one that we have covered on the podcast before. But now this one got a heck of a lot more interesting and you know, one of my favourite things in the world is a bidding war, right?

Michael Kesslering: Oh, hell yeah. Yeah, we love a good bidding war.

Julian Klymochko: We have a bidding war, potential bidding war brewing. It is not official yet, but man Canada continues to be a great market for arbitrageurs. Initially earlier this year, there was the ferocious bidding war for TSX-listed Guyana Goldfields, which was a massive win for arbitrageurs who got involved. I believe if you got in after the initial bid came out, I think that was around 80 cents and now it’s at a buck 80. So you’ve more than doubled your money. Very quickly it is a sizeable position in the Accelerate Arbitrage Fund, which we bought on day one. So a big win for us there on Guyana Goldfields. Now another potential bidding war, maybe emerging as an investor group led by two brothers, Matthew and Tyler Proud and I’m really tempted to make a bad pun here, but I’m going to stay away.

Anyway, these two brothers, they submitted a 72-cent cash per share offer for newspaper company Torstar. As listeners recall Torstar is a current, a merger arbitrage candidate. They have a friendly acquisition deal to be acquired by NordStar Capital. Which is another group of two investors paying 63 cents per share roughly $51 million deal and why this deal was so interesting and controversial to us when it first came out is that. Everyone knows newspapers are dying business and Torstar, the producer of the Toronto Star. In addition to other media properties, it was on a long-term decline. The stock had been absolutely crushed, but it was trading way below its net cash value. It was an old fashion, Ben Graham net-net, and then NordStar Capital came along paid I mean a decent premium for the stock, 58% to get to 63 cents per share.

But you know, how much net cash on hand net of debt do they have on their balance sheet, like closer to 80 cents? Right? Our thoughts was that the Torstar board was effectively giving away the company for less than free and we thought shareholders would have been better off liquidating the company and just paying out dividends. So it’s really nice to see someone potentially recognize that value or recognize value that’s greater than a negative 20 million, so that’s good to see. Now this was rumoured in The Globe and Mail yesterday. Stock got halted today, press release from Torstar came out. It is not a definitive deal. This overbid, this offer, which the Torstar board deemed reasonably expected to constitute or lead to a superior proposal. That is where they are at now. It is still subject to due diligence and a definitive agreement.

We do have the initial Torstar deal vote coming up in a couple of weeks, so this will be something quick. We will figure out if this is deemed a superior proposal in which NordStar has given their right to match typically, you know, three to five business days. And if they do then they’ll bump their bid to the a 72 cents cash per share, which is 14% more than NordStar currently paying. So kind of the crux of this story is that Torstar had a negative implied enterprise value. NordStar was basically using Torstar cash to take out minority shareholders, which kind of sucks as a minority shareholder. But when we got in, I mean the merger yield was about 20% annualized. You had good downside protection given cash on the balance sheet and it was a solid deal, and now you have this tremendous upside optionality of other intelligent investors coming along and being like, hey; this company is worth more than negative 20 million. Let’s do something about it and it looks like the proud brothers are doing something about it, trying to get their hands on that $70 million in cash. In addition to that, cash. Torstar has a bunch of valuable non-core assets, don’t they?

Michael Kesslering: Yeah. They have a few investments, in other firms, other start-ups as well which are obviously of some value. It becomes a little bit more difficult to ascribe a value to those. And the other aspect is that I guess not to overlook is that yes, we weren’t fans that it was being acquired for less than its net cash. However, the company was operating at a loss.

Julian Klymochko: Melting ice cream.

Michael Kesslering: Yes and so part of the thesis is that whoever does acquire it, they have to have a view on how they’re going to turn around to at least get it to, you know, cash flow break even. But just looking at this situation, it’s kind of a good example of how. Warren Buffet really well known. Both him and Munger are really well known for really thinking about things in probability trees and what Buffet’s especially well known for and which always impresses reporters. Is his ability to do probabilities especially multilevel probabilities in his head in real time, which is a unique skill to buffet, as well as anybody that is very good with mathematics,

But when looking at this situation. So you really just have to look at through a variety of steps here. Number one, when you are looking to value this, put a value on what this stock should be trading at right now. Well and obviously, the market views this as legitimate as the stock did close at 72 cents, so there is some legitimacy here as well as Torstar did acknowledge the offer, but what they first need is an actual formal offer from the new bidders. Then you would have to describe a probability to Torstar board that deeming it a superior offer. And if it does come through as a formal bid, that’s pretty much guaranteed that unless there’s all sorts of financing conditions or things of that nature, that it’s going to be viewed as a superior offer as it’s just simply higher.

But sometimes there will be some complexity if there is other conditions involved. Then at that point, as you had mentioned, Julian. NordStar would have the ability to match that or else the company would move forward completing this new deal. If NordStar matches perhaps the new bidder bumped their price, as you had mentioned, the net cash amount is in the 80 cents range. So potentially that could be a range that these bitters are willing to go to but it really depends on their view on post-closing. Some of those non-core assets, what the value of those are post-closing operational losses or cash flow positive gains that they are able to squeeze from it but overall, you are looking at that situation, you are looking at the probabilities in different branches of the tree. But at the end of the day, like I had mention before, and you had mentioned Julian, we love a good bidding war, so hopefully we are able to see one here again.

Julian Klymochko: Yeah, you hit the nail on the head. Nothing I liked better than getting an overbid and a merger arbitrage situation. That is really, where the big returns are made. Obviously for disclosure purposes, we are long a Torstar and the Accelerate Arbitrage Fund. And obviously we’re liking this, but I caution listeners, as you indicated, this is not a definitive deal subject to due diligence, not deemed superior yet. However, if they satisfy that due diligence condition, which I believe they will, then they will likely strike the deal here at 72 cents and then an investor has got to think, well, what’s the probability that NordStar would match or even beat this proposal leading to a bidding war? Well, unfortunately, a NordStar previously indicated they would not participate in an auction process. That is obviously you can’t hold them to that. Who knows, perhaps it has just talked to discourage others or game theory with the Torstar board of directors, but we will see, it has a really, really exciting situation.

One worthwhile watching and if you are participating from the long side, certainly that is a great spot to be in, but that is about it for us this week on episode 76 of The Absolute Return Podcast. Hope you enjoy it and then if you did check out more at absolutereturnpodcast.com for sure, go on Apple, Stitcher, Spotify, give us a good rating and then definitely follow us on Twitter. Mike, where can they find you on the old Twitter machine?

Michael Kesslering: My handle is @M_Kesslering

Julian Klymochko: And mine is at @JulianKlymochko, K-L-Y-M-O-C-H-K-O, we wish you all the best of luck in your trading, investing and speculating, short selling too, perhaps. That being said all the best we will chat with you next week. 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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