We always knew that disclosing shorts would be more controversial, given how few funds do it, but our Platinum Asset Management story escalated even quicker than we thought it would.
In our last blog at the very end we mentioned that we had reduced the position. The last three weeks is evidence why actively managing a short position is so important. The large rally in the stock enabled us to short more at better prices, thus locking in higher profits.
Platinum Asset Management (PTM) announced last week that they were going to buy back up to 10% of their stock in the next 12 months “..if the PTM share price trades at a significant discount to its underlying value” and which can only be construed as a response to the growing short interest.
What was interesting to us was that they used this as a response. We blogged about our short position in Woolworths and, like PTM, there was a substantial short base in the stock. However, Woolworths took a different approach to the high level of short interest: they set about trying to fix their business. Because ultimately the best way to force a short to close their position is to invalidate their thesis.
Before we go on, and this has nothing to do with PTM, consider an alternate hypothesis for a minute. A number of buy side investors’ talk in the media about how good the business is. The stock rallies hard. Yet how many times do you see companies reacting to a capital raising with a press release “Company X has announced a large share issuance as the stock price is trading materially above its underlying value”? Yep, we haven’t seen many of those either.
Most companies have some internal valuation in mind and most likely they will be using a Discounted Cash Flow (DCF) model to estimate the value of the business.
Firstly, in a DCF excess cash is already valued. So whilst the buyback may be EPS accretive, it doesn’t change the value of the whole business from our perspective as we had already modelled the cash.
Secondly, PTM doesn’t have enough cash on balance sheet to fund the buyback. We’re not pointing anything new out here – the Morgan Stanley analyst wrote this in his note – as the payout ratio is near 100% of earnings already. Morgan Stanley also correctly pointed out that using up the cash would constrain their growth options for the European funds they are launching.
No, we’re not discussing the value of Sydney Airports or Port of Melbourne. Rather, Terminal value is the ending value of cashflows in a DCF. So our question is – what is PTM using in their DCF for their terminal value?
This is the most interesting and perplexing area for us. We didn’t blog last time about this, but it is a topic that has been at the front of our mind since we started looking at the stock.
One way of looking at what PTM is doing is to think of the firm as a dividend maximizing model with a short dated life. In this view, nearly all the brand value is wrapped up in Kerr Neilson, so it makes sense to run remuneration levels at low levels versus peers. If this is a bit confusing, the question can be framed this way: would an investor prefer to buy a business that Kerr is in charge of for 2 more years or one in which he is in charge of for 10 more years? Clearly they would pay more for the latter.
So when we model running margins at current levels; pay out cash flow; hold FUM constant; but when he retires from the business we put no terminal value in the model and assume the business shuts down. Under this scenario it is hard to get above the current price if there is no Terminal Value. The reason is that the terminal value usually accounts for a large portion of the value of a business, particularly ones on high P/E’s such as growth stocks.
So, the other way to run the model is to put a terminal value in, but pull margins down to reflect the business becoming more like other listed stocks in the sector where salaries account for 40%. But once you start doing that, earnings drop away swiftly at the front end of the model before the terminal value. This is why we have trouble reaching higher valuations for the stock.
Lastly, whilst we have outlined publically our concerns, there are currently 19.7m shares of PTM short sold (Figure 2). We are just one of many.
PTM was quoted in the AFR as saying there is “False pattern recognition” being used by investors. There is a funny effect in science where discoveries are often made simultaneously by scientists, where two people reach the same conclusion independently. It’s part of the view of evolutionary models of science.
We have no idea who the investors are that have added 15mn shares short sold in PTM this year. They don’t publish, but clearly a lot of other people reached the same conclusion around the same time…
Source: BofAML (based on ASIC data)
We would hope that, for investors’ long PTM stock, some of our concerns are addressed by management in a thoughtful way and at the very least, the publishing of our thoughts on the industry assists in framing both the problems and potential solutions.
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