Portfolio changes

After long last, I have some portfolio changes.

One month ago, I reevaluated my Apple position. At $1t market cap, the company becomes too big to offer reasonable return with any margin of safety. I remember in December 2018, the market was overly pessimistic with several articles challenging the shift to service and their problems with China etc. Nothing much has changed. But, the stock has climbed nearly 50% from $150 to $220. All things aside Apple is very cheap at 12x earnings but not cheap at 18xearnings.

I would have likely done nothing if an opportunity had not presented itself.

Interactive Brokers came up with an IB Lite product. This is a great move which brings forth the distinction between IB pro and all other brokers.

* IB does not sell order book to market makers

* IB pays reasonable interest on cash (libor-0.5%)

* IB has the lowest commission.

What does not work in IBs favor is it’s platform which is targeted at traders. There is a learning curve.

IB Lite (no comissions, sells orders for money) with a good app will be a game changer!

Meanwhile, Schwab and Ameritrade announced 0 comissions. They will still continue to sell your orders and pay almost no interest on your cash.

IB has a great product and is playing a game that others can’t! Their smart routing tech saves a lot of money for now IB Pro customers.

I have replaced Apple with IB.

On other front, IB is an owner operator with the founder owning ~ 80%. They have ~ $6b of regulatory capital while they only need $1.5b!

It is a well run and safe broker and is the cheapest around. This is a hard product to compete with.


Booking Holdings (BKNG) is an interesting business. They own booking.com, OpenTable, Kayak, & Rentalcars.com. They also have significant exposure to Asia via minority investments in Ctrip, DiDi and outright ownership of Agoda. The management has done a great job of building the business for the long term.

Booking currently trades at a forward PE of ~ 17. This valuation hides a couple of things:

  • Booking has approximately $7b in cash, $8.7b in debt but interestingly they have $8.6b in long term investments. The split of the long term investments is as follows:
    Government securities & corp debt: $5.85b
    Ctrip (China):                                   $2b
    Didi (China):                                    $707m
    In particular, we can easily take out $6b from the market cap for computing EV.
  • Booking had offered three tranches of convertible debt of $1b each
    Mar 2012 $1b@$944 due Mar 2018 ($1.4b cash outflow for settling)
    May 2013 $1b@1315 due June 2020
    Aug 2014  $1b@2055 due Sep 2021
    The cash situation for 2018, hence, suffered by nearly $1.5b because of this outflow. Obviously, the outflow will happen in 2020 and 2021 BUT booking has stopped offering convertible debt now. All their nearly $7b long term debt is senior notes.

It looks like booking is actually cheaper than what the superficial analysis tells us.

Competitive Landscape

The competitive landscape where booking.com operates make me very uncomfortable.

Booking’s strategy is to spend on brand advertising. This will result in a user coming to the booking.com portal directly. Right now, a lot of booking.com customers take one of the following routes (1) they are referred via a meta search engine (Trivago/Tripadvisor), or (2) they click on an ad by Google based on the standard keyword based targeting. Given that booking.com has a large enough inventory, a user coming directly to booking will find a fitting accommodation.

On the other hand, Google has been making significant inroads in the travel space. Their flights offering is great! And they are working very aggressively to get the hotel booking experience right. They do not want to do what booking.com is doing i.e., sign up a lot of inventory and act as a middle man between the guests and the hosts. Google is making progress in the meta search space. If you look for “hotels in <city>” they already have a good meta search where you can see which portal offers you the best price. Maybe, even the portal of the hotel sells it cheaper than booking?

Another source of competition is AirBnB. As a business, I like booking much more than AirBnB. AirBnB has two major disadvantages compared to booking.com

  • You do not get an immediate confirmation. You may need to go back and forth over a couple of hours. This kills the experience for me. I already spent a lot of time getting the accommodation right. I don’t want to start the search all over again if the host does not accept me.
  • AirBnB destroys the neighborhoods. It is hard to find places to rent for locals because tourists pay more. I also think that it makes it very difficult for city officials to enforce and maintain the constant influx of tourists if they can live *anywhere*. A lot of places are struggling to cope with over-tourism and we as a society need to come up with ways to handle it. Because this problem will become worse as more and more people move to middle and upper middle class across the developing nations.


I think I can’t make a good call here. Even if I did invest in booking because I like the management and the business, I will not be willing to put more than 5% of my portfolio in it. This is because there are too many people out to get you and you are mostly competing on price.


Restaurant Group (LON:RTN)

The Restaurant Group operates over 500 restaurants and pub restaurants. Its principal trading brands are Frankie & Benny’s, Chiquito and Coast to Coast. The Group also operates Pub restaurants and a Concessions business which trades principally at UK airports.

It does approximately £600M of revenue and £128M of EBITDA. At the current prices of £3.45/share, the company is selling for £712M and has very low debt (new £38M). Depreciation is ~ £40M.

Red flags: New CEO. Not a significant insider holding (~3x annual salary). Vanilla shareholder letter.

Investment thesis: 10% dividend. 10% growth. Low debt. No share dilution. Investing in growing the business.

Remuneration: Financial performance measures (profit before tax, earnings per share (EPS) and total shareholder return (TSR)) are used as the key performance indicators (KPIs). The combination of EPS and TSR performance conditions provides a balance between rewarding management for growth in sustainable profitability and stock market outperformance. TSR is a clear indicator of the relative success of the Group in delivering shareholder value and, as a performance measure, firmly aligns the interests of Directors and shareholders. The EPS target range will require growth from the current all-time high level of profitability and the TSR condition will be based on recent share price performance. Performance against EPS and TSR targets are reviewed by the Committee

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Cullen/Frost Bankers (CFR)

I recently started a position 50 share position in CFR @$44. I see this as a very long term investment and will continue to build the position if the price goes south of $42.


The management at CFR is very stable. They believe in promoting people from the inside.

Phil Green, who has been with Frost for 35 years and has served as chief financial officer since 1995, is now president of Cullen/Frost, with greater responsibility for and involvement in all areas of the company. Jerry Salinas, who has served as treasurer for 18 years, is now chief financial officer. Paul Bracher, who has been with Frost since 1981, is our chief banking officer, with responsibility for, and as a steward of, our banking operations. And Bill Perotti who, in his 34 years with Frost, has been responsible for both credit and risk, is focusing more time as chief risk officer. – AR 2014

The average tenure with the Company of the five Named Executive Officers included in this proxy statement is in excess of 35 years. – Proxy 2014

Also, the management has significant skin-in-the-game.

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The CEO gets paid according to the net income of the company (traditionally capped at 0.8% of net income). But, it has been generally around 100% of his base salary. The performance measure for the CEO is very qualitative. Frankly, I don’t know how they actually arrive at anything reasonable.

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The primary criterion for annual incentive payments for the Named Executive Officers (other than the Chief Executive Officer) is the measurement of financial performance vs. budgeted net income for Cullen/Frost.


The business has done quite well over the years. Here is the balance sheet data from 2010 to 2014 (right to left).

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The growth in deposits have been 10% for the last 5 years !

Frost Bank received the highest ranking in customer satisfaction in Texas in the J.D. Power and Associates 2014 U.S. Retail Banking Satisfaction StudySM for the fifth consecutive year.

At the current price, the company is paying 5% in dividend. So, at current prices, I am looking at a return of > 12%.

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The earning per share on the other hand, has only grown at 4.4% a year during the same time period (2010-2014). This has been happening because of the fed rate being so low.

The Corporation is primarily funded by core deposits, with non-interest-bearing demand deposits historically being a significant source of funds. This lower-cost funding base is expected to have a positive impact on the Corporation’s net interest income and net interest margin in a rising interest rate environment. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) repealed the federal prohibition on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts beginning July 21, 2011. To date, the Corporation has not experienced any significant additional interest costs as a result of the repeal; however, the Corporation may begin to incur interest costs associated with certain demand deposits in the future as market conditions warrant.

So, if the Dodd-Frank Act does not ruin the advantage completely, the earnings of CFR will increase nicely in a higher interest environment.

The Corporation’s balance sheet has historically been asset sensitive, meaning that earning assets generally reprice more quickly than interest-bearing liabilities. Therefore, the Corporation’s net interest margin was likely to increase in sustained periods of rising interest rates and decrease in sustained periods of declining interest rates. In an effort to make the Corporation’s balance sheet less sensitive to changes in interest rates, the Corporation entered into various interest rate swaps which effectively converted certain variable-rate loans into fixed rate instruments for a period of seven years.

Second Level Thinking

Why is the company cheap ? The recent drop in oil prices has scared the investors. This is a Texas bank and CFR itself says that they have exposure to oil companies.

Outstanding loans in the energy sector represent about 16 percent of our loan portfolio. That means that 84 percent of our loans are in other sectors, so our portfolio is very well diversified.


Investment mistakes: Fortress Paper (FTP.TO)

Summary: I bought Fortress Paper (FTP.TO) starting Oct 15, 2013 and exited my position on Jun 5, 2014. The average buy price was CAD$4.57 and the sale price was CAD$2.83. I lost CAD$881 on an investment of CAD$2,291. This post will detail some of the lessons I learned from the fiasco.

Investment case: The investment case for Fortress was not very complicated. It was a jockey stock with significant amount of assets. The owner had already successfully turned around the wallpaper making factory in Dresden (Germany) and was close to doing a similar thing with the note printing factory at Landqart, Switzerland. The company owned a Dissolving Pulp mill at Thurso, which was facing some operational difficulties and a threat from China about duties. Both of the issues seemed overblown — if the management were to be believed. It turned out that the first one was but the second one was not. The company had a book value of CAD$25 per share when I started buying.

The Chinese levied a charge of 13% on Thurso mill and near 50% on the yet to be developed LSQ mill — completely making LSQ unviable. The continuing low cost of DP persisted, making the Thurso mill unviable for long. Fortress sold the Dresden mill at a significant profit. But now, they could use the profits to continue investing money in their loss making mills i.e., Thurso, Landqart, and LSQ.

Lessons Learned

  • The company was one of the low cost producers of DP. Price pressures would have made the competition disappear and at some point FTP would have generated significant cash. Unfortunately, the Chinese duty took away this significant advantage. It was believed that China will not risk putting duty because it will open up opportunities for duties by Canada on Chinese goods. But, they did it anyway. The lesson here is to be wary of government intervention.
  • The jockey i.e., the CEO had some questionable compensation practices. He rewarded himself amply with stock options and such. I do not back away from paying a good management well. But it seems that the greed puts the manager in a questionable light.

Mental dissonance

I had ended up owning stocks which I did not necessarily believe in but stayed invested because of several reasons — which can be likely be grouped under the term “bullshit”. I was coat-tailing in some (BAC, SAN) and hoping for a turnaround in others (FTE, EOAN).

I was reading this excellent blog by Prof. Sanjay Bakshi and came across the case of “three legged stool” [read it here]. I have suffered from this fallacy for a while now.

Today I decided to sell every company in my portfolio that I did not understand or had done insufficient research on to justify an investment. Bank of America, Banco Santander, Orange and E.On for example are too big and convoluted to get a clear picture of. In case of E.On and Orange — the management does not seem focussed on creating shareholder value.

I now own the following companies: Fortress, Tesco, Altius, Weight Watchers, Nam Tai, ArcelorMittal, Intel, Bouygues, CAF and PostNL.

I have decided to add an item on my investment checklist. Draw a line, which if crossed will qualify the position to be sold.

I also sold PostNL, mainly because they have decided to sell their TNT stake to shore up their balance sheet. This destroys the margin of safety for which I invested.


Weight Watchers (WTW)

Weight Watchers (WTW) is a very promising pick.

There are two things that might go wrong with the company.

One is its huge debt load. The long term debt for the company was $2.4 bn as of Jun 29, 2013. The interest expense for the debt was $50 mn in the last 6 months. The company has very nice cash flows and the interest is well covered. Furthermore, the debt is due a long time in the future. Here is the summary of the long term debt.

Long Term Debt (WTW)


The second problem is the challenges the company faces in the market. I am convinced that any weight loss diet should have a social component, otherwise people go back to their old ways. This is probably one of the significant reasons why Weight Watchers has some success in this area. Mobile application will have a difficult time offering the social  component and face to face interactions. The problem is that WTW may perform poorly for a few years.

The high debt load complicates the situation in this sense. If the business continues to suffer than WTW might have problems with the lender banks.