Sohn Conference Foundation

New York 2016 conference review

HAMLIN LOVELL

The Sohn Conference Foundation (‘Sohn’) turned 21 this year and it embodies the ethos that is the guiding star for many of the world’s leading hedge fund managers: combining successful investing with philanthropy.

Since 1995 Sohn has raised over $70 million to fund research, technology, treatment and care around pediatric cancer and other childhood diseases, in memory of Ira Sohn who passed away from cancer aged 29. Companies and individuals wishing to support the foundation can do so through corporate sponsorship, becoming a Sohn Partner, or taking the Sohn Pledge Program. Donations of goods and services benefiting patients can also be made in kind. Most donors, which include leading hedge fund managers, service providers, professional associations, trade bodies, and individuals, are named, but a few choose to remain anonymous. Some of the top hedge fund managers start investing at university or even as teenagers at school, and anyone, including undergraduate students, can also participate through the Sohn Idea Contest.

More detail and case studies of those helped by Sohn are available on the website http://www.sohnconference.org/; here we want to touch on some of the investment ideas discussed at the New York event held in May 2016, which kicks off the 2016 season as the first of seven Sohn conferences being held this year. Later on Sohn events take place in Hong Kong and India in June; San Francisco, Canada and Tel Aviv in October, and London in December. Funds raised at each event are devoted to local projects in each country.

One core concept behind the Sohn conference is that those who profit from trading the ideas floated at the event may be inclined to donate part of their gains to Sohn, through the Sohn Pledge Program. Below we briefly outline some of the investment theses but in this amount of space we cannot possibly do justice to the rigour and tenacity of the analysis that was apparent from speakers’ presentations (some of which are made available online).

The Sohn conference permits media reporting (but not recording) and we appreciate this freedom. We are well aware that some hedge fund managers refrain from commenting on individual equity holdings, which are consequently absent from some of our manager profiles.

Macro views
We start with macro views before moving onto long, short and relative value equity ideas. Stanley Druckenmiller, Chairman and Chief Executive Officer of Duquesne Family Office LLC, seems concerned that after eight years of sub-par economic growth, the marginal effectiveness of stimulus is waning. In his view, the equity bull market, driven by M&A and buybacks, could be looking long in the tooth. Druckenmiller also argues that earnings management, misallocation of capital, and aggressive accounting are already taking their toll. He reckons that the corporate profits recession began earlier than commonly thought, with the US corporate sector share of the economy having peaked as early as 2012. All of this means that a US equity valuation multiple of 18 times is too rich for Druckenmiller’s blood.

David D’Alessandro, founder and CIO of CMDTY Capital Management LP, is one of several launches to have spun out of Ziff Brothers Investments. D’Alessandro previously traded for a Glencore/Credit Suisse JV, for Tudor Investment Corporation and at Sempra Energy Trading. CMDTY expects higher oil prices will be needed to balance the markets out to 2017 and 2018. The manager sees supply constraints coming from capital spending cuts; lower non-OPEC production including in the US, UK, Norway, Kazakhstan and China; and the fact that hundreds of millions of barrels of oil perceived to be part of headline ‘inventory’ figures may never be released from strategic reserves, principally in China and India. On the demand side CMDTY is relatively upbeat, citing South Korea as one first derivative indicating China’s economy has not collapsed, India’s industrialisation being analogous to China’s in the 1990s, and healthy demand for US gasoline.

By way of contrast, Zachary Schreiber, Chairman, Chief Executive Officer and Chief Investment Officer of Duquesne spin out Point State has a distinctly less sanguine outlook for oil prices, pointing to shale growth of 15% per year, continuing deleveraging in China, and the longer term possibility of electric cars displacing half a million barrels per day of demand by 2020 (and as many as 3 million barrels per day by 2030). This cautious oil price view forms only one plank of his arguments for shorting Saudi Arabia’s currency, however. Point State is also concerned by Saudi Arabia’s escalating budget deficits that suggest it could be structurally insolvent within two or three years.Nor does Schreiber see the Aramco IPO as plugging the gaps; to the contrary he thinks the loss of this cash cow could make it harder for Saudi to balance the books. Capital flight could get worse and Schreiber anticipates that a break of the riyal’s peg to the USD could generate payoffs many times the cost of putting the trade on.

Another country that may have unsustainable fiscal arithmetic is Japan, in the opinion of Adam Fisher, Co-Founder and Chief Investment Officer of Commonwealth Opportunity Capital GP, whose earlier career included risk arbitrage, private equity and real estate investing. Fisher argues that debt growth is essential for economic growth and that in spite of interest rates near zero, a lack of demand for loans is preventing the Japanese economy from growing. Yet Fisher thinks Japan may have the political will to borrow yet more and reflate. Therefore, the 30 year Japanese government bond yielding around 30 basis points has become the world’s most overpriced security where a 10 basis point increase in yields causes capital losses costing 10 years of returns. In contrast Fisher views German government bonds today as akin to JGBs three years ago, and owns them.

If German government bonds have the lowest yields in the Eurozone, Greek government bonds, offering the highest yields in the single currency area, appeal to VR Capital Group Ltd Founder, President and Fund Manager, Richard Deitz. He thinks the 8% spread over German debt could compress. Deitz also finds Greek bank stocks offer compelling risk/reward. Now that the dust has settled the four systemic Greek banks together have a 95% market share in Greece and their valuations, around one third of book value, seem too low for Deitz. Recapitalisation of the Greek banks has bolstered their capital ratios and Deitz thinks that their provisioning could prove to be too conservative. Reversing and releasing provisions could allow the banks to rebuild capital and eventually return it to shareholders. These theses would be helped by further support from the ECB, including access to its standard refinancing window and inclusion of GGBs in QE.

Equities
Elsewhere in Southern European banking, ex-Farallon David Leone, founder of David Leone and Partners Investment Company LP, thinks that Italian bank de-mutualisations are worth watching. So inflated are some Italian banks’ cost to income ratios that each 1% point drop in the ratio could add 12% to net profit.

Domand Capital Management LP Founder and Portfolio Manager Nick Danaher sees multi-bagger potential for Tripadvisor, which has used the breadth and depth of its content to build a loyal base of very engaged followers. The Instant Booking feature is now allowing Tripadviser to monetise its franchise more powerfully. Domand looks through the share price volatility and habitual earnings misses to the firm’s longer term potential. He envisions Tripadvisor might one day be worth as much as Expedia or Priceline, based on what he thinks are conservative assumptions about conversion rates and commission rates.

Another travel-related stock is losing market share, says ex-Jericho Capital Partner Genevieve Kahr, founder of Ailanthus Capital Management LP. Kahr was selected for EY and The Hedge Fund Journal’s biennial ’50 Leading Women in Hedge Funds 2015’ survey and was in fact the only woman portfolio manager presenting at Sohn New York this year. Kahr observes that erstwhile in-the-sky wifi monopolist GoGo has seen its market share collapse from 94% to 60% as new players have entered the market, and as key customers have defected to rivals, some of which have lighter weight antenna. Despite being vilified on social media and sued by one airline customer, GoGo has tripled its retail prices. But Kahr thinks its share price should be lower.

Deep value specialist, Point 72 alumnus David Rosen, of Rubric Capital Management LLP, thinks that Kraton Performance Polymers is misunderstood by the markets. It is perceived as a cyclical commodity play tracking the butadiene price, and is ascribed a low valuation multiple commensurate with a volatile earnings pattern. Yet Rosen sees Kraton moving up the value chain by shifting its business mix to higher margin speciality polymers. Cost cutting and restructuring could boost free cash flow, which is a more useful metric than GAAP earnings that are being depressed by Kraton’s accounting policies. Rosen thinks stock could have upside to between $65 and $97.

Another former Point 72 manager, Nick Tiller, had a spell as a ‘social entrepreneur’ setting up Sustainable America, before founding Precocity of which he is Portfolio Manager. Tiller’s thesis for Royal Dutch Shell is predicated less on higher oil prices, and more on cutting capital spending and its exceptionally strong output growth for a super major. Tiller thinks that Shell is trading at a deep discount to his sum-of-the parts valuation including Woodside, chemicals, refiners, LNG, and upstream businesses; he further argues that Shell stands at a 60% discount to Exxon even though the two of them are partners in many common projects. Moreover Tiller thinks Shell can sustain its 7% dividend yield.

Another ‘social entrepreneur’, Chalath Palihapitiya, belonged to the senior executive team of Facebook before founding Social Capital LP. Palihapitiya reckons Amazon could be worth $3 trillion partly from doubling its customer base. While he is very excited about the retail business – which he thinks could be worth $1 trillion one day –  it is Amazon’s Amazon Web Services (AWS) cloud computing division that he thinks may be worth as much as $1.5 billion if an IBM, Intel or Oracle multiple is applied to projected financial metrics.

Oaktree Capital Group founder Howard Marks revealed what was the most lucrative investment discussed on the day. He estimates that Oaktree’s investment in Jeffrey Gundlach’s DoubleLine Capital LP, is now worth 50 times the original $20 million. Gundlach proposes a relative value trade with a contrarian flavour: shorting an ETF of utilities and buying one that owns mortgage REITs.

Another manager is also upbeat on some parts of the real estate sector. John Khoury, Founder and Managing Partner of real estate specialist Long Pond Capital LP, views hotels as something of a Cinderella sector that has lagged REITS by 30% in what he judges to be a rather indiscriminate sell off. Khoury acknowledges that some lower end hotel chains do face headwinds, including RB&B, but he insists that higher quality franchises warrant higher valuations. Khoury thinks that Hyatt’s own trophy properties could be worth $655,000 per key with its other assets valued at $250,000 per room, while its franchise business has strong growth in rooms. Share buybacks are another kicker and Khoury sees 70% upside.

Larry Robbins, Founder, Portfolio Manager and CEO of Glenview, refrained from making explicit stock recommendations, but did list a number of stocks that he thinks have been harshly punished by the rout in healthcare stocks, including pet healthcare specialist Ventab, drugmaker Abbvie, assisted living firm Brookdale, and managed healthcare group and takeover target Anthem. Robbins reckons his portfolio is trading on 11 times 2017 estimates versus 15 times 2016 estimates, which would imply spectacular earnings growth next year.

Also perceiving value in a healthcare related stock is tenacious activist Jeffrey Smith, Managing Member, Chief Executive Officer and Chief Investment Officer, of Starboard Value LP, who claims to have replaced 150 board members in 50 companies. He is currently grappling with the intransigent management of pain relief drug company Depomed. Smith envisages growth from Depomed’s shingles, migraine and breakthrough cancer treatments but feels that as an independent entity the firm is not fulfilling its potential for shareholders. Expensive debt and a high tax rate could be remedied by a takeover but Depomed rebuffed a suitor with egregious tactics including a poison pill and measures that render it pointless to try and requisition a special meeting. Smith is persevering with Depomed.

Also categorised as an activist is Carson Block, Chief Investment Officer of Muddy Waters Capital LLC, though he is most well known for short ideas. Block thinks that the Arizona-based Bank of the Ozarks is unusual in several respects: 90% of its book is real estate loans, almost entirely in the commercial and construction space, and 65% of the book is made up of unfunded loan commitments that are made without demanding personal guarantees. Block is concerned that Ozarks is exposed to vulnerable property markets (including New York, Los Angeles, San Francisco and Miami), might need to raise capital, and follows accounting policies, including provisioning, that are more aggressive than at other banks.

Another veteran shorter, Jim Chanos, Founder and Managing Partner of Kynikos Associates LP, invests for both long and short alpha. But he is most renowned for short selling, and sees numerous tailwinds for a telecoms company that currently boasts eye popping margins. MTN’s main markets of South Africa and Nigeria are both in the eye of the commodity price storm, and both have politicians who need to raise tax revenues, not to mention growing competitive threats.

As President of Greenlight Inc, David Einhorn has just celebrated the hedge fund manager's 20th anniversary, over which period it has made 1750% versus 350% for the S&P 500. At Sohn, Einhorn told a tale of two cyclicals. The paradox of cyclicals’ valuation multiples is that they can appear cheapest when they are most expensive (when at peak earnings) and they can seem priciest when they are actually the best value (when at trough earnings). Einhorn contends that the market is out of sync with the earnings cycle that he projects for two firms. If the maker of gargantuan trucks, Caterpillar, has not yet touched trough earnings, then its valuation multiple of 22 times is grossly bloated. He sees potential weaknesses in all of CAT’s divisions: coal is in secular decline, the high margin mining business could have further downside, and railway capital spending is dropping. All in all Einhorn thinks earnings could almost halve again by 2018 from today’s level and warrant a lower multiple. Auto-maker GM is the reverse case: Einhorn thinks its valuation of six times earnings – one of the lowest in S&P 500 – discounts a collapse in earnings that he does not expect to materialise. Einhorn acknowledges that GM’s North American car sales might come down but points out it is also a leader in China. Returning capital to shareholders, via buybacks and dividends, adds to GM’s attraction. The New York presentations ended with Einhorn, who has been a regular fixture at Sohn for many years. We expect that Sohn will continue to showcase many established and rising star hedge fund managers over the next six events in 2016 and in future years.