A mentor passes on.

The knock on the door was unexpected, after all it was 8 AM on a Saturday, it was raining hard outside, and we were leisurely enjoying the morning in bed.  But up the steps to our beach house they came,  it was all we could do to get my clothes on and get to the door before they were headed back down again.  The person introduced themselves and in my morning fog we did not fully catch the name.  But when we asked again the name "Pace" came through clear as in his father's son.  In the car below was his mother and he began to tell us his father had passed on late the day before.  Shock hit me hard as we began to deal with the death of another mentor, but also a very good friend.  Our decision a year ago to move into Tom's neighborhood now meant we were one of the first to know of his passing. 

Tom Pace, as many use the wording, had forgot more about municipal bonds than most people know.  We were blessed to get to know him early in our investing life and sought his advice regularly for over three decades.  We also purchased the vast majority of our municipal bond portfolio from Tom, most of which we still hold.  As one mentor told us how to get the money, another told us how to make the money, and yet another told us how to keep the money from being ravaged by taxation, Tom is the one who taught us how to "put our money in salt".   In other words how to not lose what we had worked so hard to make and then let our money work for us. We encourage you to revisit our series in early 2011 on mentors. 

The last few years the lunches we had at Jordan's Seafood and Rucker Johns on Emerald Isle became a good bit of discussing family and still some discussion of stocks and bonds.  Tom still enjoyed conversations about what each of us considered the ups and downs of the stock and bond market and it was frankly a boost to our ego Tom occasionally considered OUR advise and thoughts worth acting upon.  The student had come a long way from "what is a municipal bond".  

We remember during the financial crisis of late 2008 and early 2009 when we made the decision to buy up several hundred thousand dollars of bonds at fire sale prices the teaching Tom had brought to us over the decades and how to price bonds according to their true future value. We sit on lots of capital gains today due to those decisions. 

We will miss Tom as we have our former deceased mentor Andy Augustine.  Fortunately they will live on in the teaching we got from them and how they have made our life so much better.  God bless you Tom and his family during this time of sorrow. 

Making 14% on borrowed capital.

Early on in a post on this blogging site we discussed that one of our early mentors who had been ultra successful told us the only way those of us with less capital to start life like him to make real money was to do it with borrowed capital. As we have pointed out from time to time our hedging activity is done with borrowed capital.  The idea is to do some business that makes enough profit to pay for the cost of borrowed capital and make some money for you as well.  Many of us frankly do this everyday with buying a home. Borrow capital from the bank, buy the home, and then work at a job that allows one to pay back the loan and live as well. Business people do this too when they borrow money to start a business and make enough to pay back the loan and make profits above that cost of borrowing.  Simple free market concept. 

Our hedge fund works on that concept except with a much larger borrowing capacity.  This post is to show how a current hedge we do monthly that nets us 14% profit on the borrowed capital. 

ERF is a stock we have traded for many years. We know the company and except for some political movement that caught us by surprise we understand the stock movement well.  Currently ERF is trading between about $13 and $14.  For this illustration let's make our entry price at $14.  We own 7200 shares of ERF which makes our investment right at $100k.   Each month we are paid a dividend of just over $650 adjusting for the difference between the Canadian dollar in which the dividend is paid and the American dollar in which our dividend is credited.  Every other month we sell a call option for $14 and net out $1800 for the sale.  So between the dividend and the option income we net $18600 annually from this activity. Our borrowing cost is around 4.5% averaged from both our capital providers or about $4500 annually cost of capital.  So we net out about $14000 each year from selling options and the dividend.   A nice 14% profit. 

Now frankly we do not care if the stock ever gets back to our buy in price of $14 since the hedging of the stock here is making us a tidy profit far above anything we could make with any other current investment we know.  Yes there is risk and yes there is contact study here not to get caught not knowing news about the company. But the payoff is nice and one can do all this at home at their computer. 

         

Is ANYTHING safe anymore?

We expect there are no longer held stocks in our portfolio than Centurylink.  We owned it when it was little ole Centurytel and even owned Embarq before it was merged into the new Centurylink.   When it was Centurytel we liked it, when it merged with Embarq we liked it even more.  Add in the nice fold ins that have improved their cloud computing business and the aggressive tack they have displayed in going after broadband business either television or Internet service. ( As a side note here if you have not checked out the fabulous picture quality of their fiber optic service areas find one and go check it out, we have.)  Anyway today's $9 plus slide in the stock price took us by surprise too.  We have considered CTL one of our safer choices and are locked in at 2400 shares all be it at $38 per share. Ouch there. 

Let's get some smarkyness out of the way first.  Does one not just love the 6, count 'em 6, investment and bank stock advisory services that jumped in today and downgraded CTL.  Note they did this AFTER the stock slid $9 and not before.  Seems to me if any of these services were worth a damn they would have let their investors know to get out before the stock went down.   If you are spending any hard cold cash paying for full service brokers or advisors right now either you are a fool or just like giving away your money away like Obama.  If you are not willing to spend the time to do the research on your own go buy a mutual fund and save your cash. 

Back to the subject at hand CTL and where we go from here.  After some serious study today we remain convinced CTL is a good stock and good company going forward from here.  The stock buyback might have been an effort to cover up some weakness in the revenue, but we see it as positive.  Frankly CTL has refinanced about all their debt at the lowest levels possible in this low rate economy and the best use of cash flow here likely is buying back HIGHER cost shares of it's own stock.  The buyback is about 10% of their outstanding shares which should help buoy the stock price. The reduction in dividend is a move ahead of the company going profit positive sometime in 2015.  By profit positive I mean the company in 2015 will run out of depreciation and tax credits and actually begin to pay taxes on its cash flow.  Maybe I am missing something but seems to me that is a nice thing to happen, make profits.  Of course profits means dividends will then be subject to double federal taxes unlike now. 

Cash flow remains good, revenue a bit weak but that is due to the loss of land line business.  That land line business however is being replaced by broadband penetration and in many of CTL's markets you either get it from them or you do not get it.  Where they have competition their price and quality is competitive with anyone.  Besides many forget that land line business is subsidized by federal money which makes it not worth as much as many believe and subject to ending with federal deficits high. 

Is anything safe anymore?  You would figure a long life high dividend telecom would be, but maybe not.  Not in the sense that we believe CTL got hit with the "emotional" sale today.  We have opined in the past that this market is more driven by emotion than thinking and today we saw that in full effect for CTL.   We like the stock going forward especially at the current $32 price.  

We own CTL as noted as well as FTR another rural telecom. 

             

Newspapers and newspaper stocks...any buys?

 We attended a "community" newspaper meeting last week to discuss how to improve business and how to solve common problems. As usual we find pleasure listening to and working with these front line small town dailies and weekly publications.  They work hard, take care of their employees, and frankly publish darn good newspapers that serve their areas of concern.  However the economic environment in which they operate is not a profitable as it once was in the industry.  

However most of these newspaper ARE profitable and some are doing quite nicely if you consider total cash flow.  There was a time when newspapers considered anything below 15% to 20% annual profits on total revenue to be sub par.  We remember one newspaper we had association with in the past bragging about  33% "turnover ratio" one year.   Today profits are below those percentages and sometimes in the 5% range.  Guess what THAT is quite normal in most businesses.  

The problem lies in the fact many of these newspapers built a business model on a 15% plus annual profits which included larger staffs, more leverage, and higher debt loads.  The higher debt loads generally came in the form of mergers and buyouts of family operations by large chain operations.  the big chain operators bought up family owned newspaper at high multiples ASSUMING that the cash flow would be there and they could pay off the debt with the profits.  One chain McClatchy got in deep trouble doing do with a high priced purchase of another large chain right before the bottom fell out of the newspaper business.  McClatchy in effect has never recovered from that mistake and is a shell of the operation it once was today saddled with huge debt.  Other operations such as Freedom, New York Times, and Cox just sold off what they had at what was considered bargain basement pricing to pay off some of the accumulated debt or in Freedom's case bankruptcy sale.  

The private capital who have bought these operations such as, Halifax, Cooke, and of late Warren Buffett's Berkshire are doing so at prices that would have been unheard of just ten years ago.  Private equity can move in and make money making 5% to 7% on cash flow due to the even lower cost of borrowed capital right now.  There are few big profitable chains anymore and those have trimmed staffs and cut costs to the bone just to operate under their heavy debt loads.  

Frankly the remaining newspapers that are big city dailies are in our opinion doomed to fail or become a much smaller voice in their areas of concern.   The competition in larger markets makes it impossible to carry on business as usual.   However smaller dailies and weeklies in our opinion will continue to do well as they do not see the intense local competition and are still generally the only source of local news in their areas.  No they will never see the 20 % plus profit months on a regular basis, but there is no reason they should not do 5% plus consistently in net profits.  Many of them never took on heavy debt loads and continue to be an institution in their small towns. 

Growth in these smaller newspapers will be minimal and only move with the local and national economy going forward.  In our opinion we find these local enterprises a good buy here for those looking to make purchases.   That is the reason private equity continues to do so.  Unfortunately for many investors unless one is willing to purchase the direct assets of a newspapers much of this private equity exposure is not for purchase.  Yes, one can buy some Berkshire Hathaway shares but the dilution to other businesses there makes direct exposure almost meaningless. 

We do believe there is one place one can get exposure to newspapers going forward and that is Gannett Corp., symbol GCI, which has a nice portfolio of newspapers and has stabilized it's business model recently.  Long term debt is manageable and being paid down, the stock pays a 4% plus dividend, and is diversified enough to be a going concern long term.  They are moderately growing revenue  as well.  This play is not for the faint hearted however so buyer beware if the economy turns down.  A price below $18 is more comfortable for us. 

Full disclosure we do not own GCI currently but would consider at our noted strike price.  We also perform newspaper consulting work with various concerns on a no fee basis. 

Dow at 14000

The Dow Jones Industrial average crossed the 14000 line this week and is within a couple hundred points of a all time high.  The S&P 500 is closing in on a record as well.   Simply put we do not buy it.   

The economy has double digit unemployment, interest rates at record lows, and business activity that remains weak and those factors do not make for an all time high on any exchange.   History says that high stock prices occur when unemployment is low, interest rates higher, and business activity bullish.   Check any time in the past when the stock market reached highs and you will find those points of reference.  

So why is the market approaching a all time high.  Our opinion is that the Federal Reserve is to blame or praise whatever your point of view might be for the high stock prices.   History repeats, but history can not adjust for changes in policy and in this case the policy is the extremely huge amount of money being printed and pushed into the economy.   Every month without end for almost four years the Fed has been adding 75 billion dollars of stimulus into the US economy.  Now the total is in the several trillions and frankly has reached the point those huge piles of money are chasing goods and services with abandon.  All the food stamps, federal welfare, federal and state unemployment, disability, and so forth are making for some merry times for big corporations.  Note I said big corporations and not necessarily small business. 

All be it much of that money is per capita not very big, but enough to make big corporations that have become lean by closing plants and laying off workers to make nice profits.  For the first time in history we are witnessing huge amounts of unearned money chasing goods and services where there is no one working to make the money.  Think about that for a moment big corporations do not have to deal with the cost of paying employees, but can sell lots of products to those same employees they laid off who have money to buy their products.  Makes sense that profits are doing well with all that juicy Fed money out there being spent.  The point is much of this spending is unearned or just printed paper money.  Savings and labor produce goods and services which in turn allow the saver or laborer to use their earned income to buy those services. When that income is unearned sooner or later price points must move up to accompany the added currency in circulation. The only reason they have not up to now is the economy is so sluggish we still make too many goods for the money chasing it.  Profits are high, but volume of production is not.   Imported goods made cheaply are adding to this scenario.  

Now the Fed is pumping money, but when you read their minutes you find they are not happy doing so.  They are doing so because the US Government is spending with abandon and the resulting trillion dollars plus annual deficits.  Those 75 billion dollars monthly deficits not being bought by the public or foreign governments are being bought by the Federal Reserve in any attempt to keep interest rates down to stimulate the economy.  The added benefit is that the Federal Government gets to spend wildly with no concern for normal interest rates to finance the debt.  For the most part the deficit is costing nearly nothing interest wise at this time. 

Getting back to the stock market.  It is clear that what we have here is a sugar high that sooner has the possibility of giving us a huge downer down the road.   The Fed has it's hands full figuring out how to withdraw all this cash.  Even more troublesome is how the Federal Government figures out how to cut some of this excessive spending.  We have a rendezvous with destiny here and to us it does not look pretty.  The key for investors is your timing to exit stage left.  We have already begun to consider exiting some of our profitable corporate bond positions.