Herbalife after option expiry - Part II: counting shorts and longs

With Herbalife at $31 then any puts that Ackman has (and we know the prices of them) are in the money so far that their delta is almost one.

This means if you have written a (say 100) put options to Bill Ackman and you are hedging your position you are short almost 100 shares.

If you are not short 100 shares then the puts will be exercised on you and you will wind up long 100 shares.

And if you have written 10 million puts (100,000 contracts) and you are not hedged you will wind up owning 10 million shares.

And if you take delivery of five or more percent of a company it likely you have some intentions towards it.

You may however own them deliberately (selling puts with the hope they are delivered) or accidentally (selling puts with the hope of keeping the premium).

Indeed it likely there is some deliberate and some accidental ownership of the stock.

--

We also have some idea of the size of Ackman's position. It was originally in excess of a billion dollars and between 20 and 25 million shares.

We know from various articles at the time his break-even was around $50. [This was corrected to $47 later as you will see.]

As the stock went up he restructured his position - some short, some puts.

In February 2014 he said that his position was much bigger than originally. To quote:

“We actually now have a much larger position notionally than we had initially. If it were to disappear tomorrow, we’d make a lot more than had it just blown up the day after I gave my last presentation.”

We also have an idea of where his break even currently is. Recently he told Reuters this:

"We shorted it at $47 but because of option premium, borrowing costs, dividends, investigative expenses, our break even is around $31, $32," 

You can do the maths. If it was a billion dollar position at $47 per share (and we know it was at least that) he was originally short 21.3 million shares.

His break even is now say $31.50 per share and he will make more money than originally - which means he is short at least 32 million shares (which produces the same result) and probably more than 40 million shares (which is what is required to make this a "much larger" position than originally.

My figuring is that Ackmans short plus put position adds up to something greater than 40 million shares. My guess is 42 million.

--

Now Ackman has many followers. There is Whitney Tilson (who is publicly short) and a host of Twitter gliterati who boast about being short. It is a fair guess that in aggregate they are short (say) 3 million shares.

This makes an aggregate short position of 45 million. This includes straight shorts plus puts.

--

The published short position is about 30 million.

As a conclusion we can guess that something like 15 million shares are not delta hedged.

Those puts are issued by someone who is going to take (or has taken) unhedged delivery of 15 million shares.

Given the number of puts exercised on Friday I suspect they have largely taken delivery.

--

Some of those shares are going to be delivered accidentally. The person sold puts in the hope they would not be delivered and when they are delivered they just sell the shares. This creates downward pressure on the stock. I think we saw that on Monday.

Some of those puts are sold by someone willing and able to take delivery. And most importantly wanting to take delivery.

Normally a new large shareholder has to disclose ownership at ten days (and that would be ten days after they take delivery).

And there must be some new fundamental long (or more than one) who sold those puts to Ackman. People sell a few million dollars of premium for speculation - but someone has taken delivery of hundreds of millions of dollars worth of shares - and in my experience they don't do that by accident.

We have had the first disclosure today - and it was a gentle one. UBS owns 6.4 percent.

I still think there will be another person. At least that is my count.


John

PS. There was a serious correction to the original version of this post regarding the ownership of the UBS stake.

Vale Saxo Bank

If this story in the Danish press is correct Saxo Bank is not long for this world.

Good riddance. Hope the gamblers (ahem: customers) get some money back.


John

http://www.business.dk/finans/saxo-bank-faar-kaempetab-paa-schweizerfranc

Herbalife after the January option expiry: Part 1

I have deliberately refrained from writing about Herbalife until the 17 January 2015 option expiry.

We know from public disclosures that Pershing Square (PSQ) had a huge put option position on Herbalife.

There were also a vast number of put options that expired on 17 January.

Here are the outstanding in-the-money put contracts as at market close Friday.

	issue	open interest
31.5	HLF150117P00031500	1,174
31.5	HLF150130P00031500	1
32	HLF150117P00032000	974
32	HLF150123P00032000	34
32	HLF150130P00032000	31
32.5	HLF150117P00032500	5,318
32.5	HLF150123P00032500	59
32.5	HLF150130P00032500	26
33	HLF150117P00033000	677
33	HLF150123P00033000	116
33	HLF150130P00033000	137
33.5	HLF150117P00033500	125
33.5	HLF150123P00033500	276
33.5	HLF150130P00033500	12
34	HLF150117P00034000	206
34	HLF150123P00034000	23
34	HLF150130P00034000	13
34.5	HLF150117P00034500	20
34.5	HLF150123P00034500	78
34.5	HLF150130P00034500	63
35	HLF150117P00035000	13,729
35	HLF150123P00035000	79
35	HLF150130P00035000	39
35.5	HLF150117P00035500	168
35.5	HLF150123P00035500	35
36	HLF150117P00036000	2,096
36	HLF150123P00036000	2
36.5	HLF150117P00036500	190
36.5	HLF150123P00036500	2
36.5	HLF150130P00036500	18
37	HLF150117P00037000	481
37	HLF150123P00037000	135
37.5	HLF150117P00037500	7,446
37.5	HLF150123P00037500	248
37.5	HLF150130P00037500	8
38	HLF150117P00038000	119
38	HLF150123P00038000	7
38	HLF150130P00038000	47
38.5	HLF150117P00038500	17
38.5	HLF150123P00038500	41
38.5	HLF150130P00038500	2
39	HLF150117P00039000	22
39	HLF150130P00039000	7
39.5	HLF150117P00039500	25
39.5	HLF150130P00039500	10
40	HLF150117P00040000	20,202
40	HLF150123P00040000	16
40	HLF150130P00040000	6
40.5	HLF150123P00040500	4
41	HLF150123P00041000	3
42.5	HLF150117P00042500	7,563
43	HLF150117P00043000	1
44	HLF150117P00044000	11
44	HLF150123P00044000	11
45	HLF150117P00045000	18,770
47	HLF150117P00047000	21
47	HLF150123P00047000	1
47.5	HLF150117P00047500	9,611
50	HLF150117P00050000	73,611
52	HLF150123P00052000	2
52.5	HLF150117P00052500	27,058
55	HLF150117P00055000	16,754
55	HLF150123P00055000	11
57.5	HLF150117P00057500	7,597
60	HLF150117P00060000	43,836
62.5	HLF150117P00062500	3,173
65	HLF150117P00065000	27,343
67.5	HLF150117P00067500	957
70	HLF150117P00070000	13,127
72.5	HLF150117P00072500	638
75	HLF150117P00075000	1,373
77.5	HLF150117P00077500	184
80	HLF150117P00080000	9,981
82.5	HLF150117P00082500	892
85	HLF150117P00085000	43
87.5	HLF150117P00087500	109
90	HLF150117P00090000	2,329
95	HLF150117P00095000	263
100	HLF150117P00100000	5,276
105	HLF150117P00105000	172
110	HLF150117P00110000	115
115	HLF150117P00115000	51
120	HLF150117P00120000	69
		325,520

They add up to 325 thousand contracts outstanding representing 32.5 million shares.

These options expired on Saturday morning and I presume that the stock has been delivered.

The delivery of these options may have a profound effect on the Herbalife share register. These effects will be part of this series. For reference there are less than 82 million basic shares outstanding and about 91 million diluted shares. However basic shares are the right comparable because delivery has to be effected through basic shares outstanding.

It was generally assumed that these options belonged to PSQ.

Bill Ackman however has issued a denial. To quote:

To set the record straight, 97% of the Herbalife put options owned by Pershing Square have been extended and have expiration dates up until 2016.  The January put options held by Pershing Square have a strike price of $US65 share. Pershing Square may choose to extend, sell or exercise the January put options depending upon market conditions and other factors.

Those in the know have understood that the options expiring on 17 January were not PSQ's options.

PSQ's option position in Herbalife is an off-market position.

I know the contract terms as do many others.

Some of the strikes are very unusual.

They include 44,362 call contracts [which I presume hedge a short position] expiring on 17 April with the very unusual strike price of $69.99. [The contracts represent 100 shares.]

They also include puts expiring 15 May, 11,550 contracts with a $44.50 strike and a further 19,500 contracts with a the unusual $49.99 strike.

There are a further 25 thousand contracts for calls with another $69.99 strike.

I could go on... and on. Ackman's position is well known amongst connected and sophisticated longs.

Moreover like many things that Bill Ackman says he is being cute-with-the-truth. Bill said his "puts" largely didn't expire on 17 January. He however owned a large number of calls that expired - and these calls hedge the oversized short position. For example PSQ carried 4,375 call contracts that expired this weekend with a strike price of $89.90. Presumably these hedged 437,500 short positions.

I wouldn't bother disclosing that I knew details of PSQs unlisted positions except that it is useful in future posts.




John

Post script: If you (like me) believe that Herbalife is a legitimate business and (like me) you believed that the end game was a private equity bid - then I have a puzzle for you.

How could you - knowing the detail of Bill Ackman's position - make a simply humungous amount of money at least partly at the expense of Pershing Square and their clients? Because I assure you some people want to play rope-a-dope with Mr Ackman. [If you think that Carl Icahn has really suddenly become Bill Ackman's bosom buddy then you don't know Carl...]

Secondly: I suspect that this post will cause Pershing Square's office to be quiet and unusually tense on Monday.

Can you say witch-hunt?

Sure, I knew you could.

It is time to close Saxo Bank down

Saxo Bank is a retail foreign exchange trading bank. The idea of forex trading as a retail product is mildly offensive any way. [I simply can't see how you can make money doing this in any consistent manner.]

However the (a) lack of systems and (b) depth of the scam is revealed by Saxo's statement after the giant Swiss Franc move today. To quote:

“Due to today’s exceptional market movement in CHF crosses, we have been filling client orders and positions in an extremely illiquid market. Once we are better able to establish true market liquidity, all executed fills will be revisited, and will be revised and amended to more accurate levels. This may result in a worse execution rate than the originally filled level.”

It is of course garbage of the highest order that in the biggest currency movement of recent times there pertained an "extremely illiquid market". If Saxo quoted the wrong price the problem is Saxo's systems.

Instead Saxo is just stealing from its clients. It did a deal and they traded at a rate - and they are rewriting that deal to suit them.

Theft is the right word.

Any regulator that lets Saxo Bank do this is failing it core functions.

Saxo bank's licenses should be revoked.





John

Hat-tip to Reuters.

Disclosure: no positions.

The return of cookie-jar earnings: United Technologies edition

I was just listening to a November presentation made by United Technologies - a large and very fine American company. Mostly I was listening for the comments on Pratt & Whitney as Bronte has multiple investments in the jet-engine business.

But I was struck with the forthrightness with which Gregory Hayes (now the Chief Executive Officer) discussed earnings manipulation. You can find the transcript here. To quote:

So we'll be able to deliver on the numbers that we had talked about earlier in the year, which essentially was in a range. We started out at $6.55; we're now at $6.75 to $6.85. We'll be right around $6.85 when the year is said and done. Still some puts and takes, some headwinds around currency. But top line looks solid at $65 billion; bottom line looks solid around $6.85. 

I'd just point out, tax extenders is not in our numbers for the year. Who knows if we're going to get extenders here in the last couple of weeks of the year. My own view is that if we get extenders, we'll probably just restructure against that benefit or do something else, as opposed to trying to pass along another dime that's probably not going to give anybody much of a benefit. So I think we're done at $6.85.

So if President Obama signs a tax bill they won't reflect that properly in their earnings they will just take a restructuring charge so they don't need to show the earnings to you.

In other words they will create "cookie jar earnings".

Cookie jar earnings were all the rage when I got into this business. Alex Berenson even wrote a book about them. What shareholders wanted was smooth earnings growth regardless of the vagaries of economic cycles - and people created cookie jars and manipulated earnings to show precisely that.

Listening to United Technologies I felt about 15 years younger. What is old is new again.





John

Disclosure: No position in any mentioned stock.

A comment on current Chinese vs Second World War Iron Ore demand

China uses roughly 700 million tonnes of steel per year (or at least used that much before recent declines).

Really good iron ore  62 percent iron - so there is at least 1.1 billion tonnes of iron ore used per year.

My summer weekend reading is Winston Churchill's history series - and I am currently on his book on the lead up to and the early phase of the Second World War.

In it he is writing to the then Prime Minister about interdicting the shipping of iron ore from then neutral Norway to Nazi Germany.

Churchill estimates that German industry needs 9.5 million [presumably imperial] tons of ore between 1 May and 15 December 1940.

During the armaments build-up phase of the Second World War Germany was using less than 20 million tonnes of iron ore per year or way less than 2 percent of current Chinese usage.

Gosh there is a lot of steel usage and capacity in China.




John

A shameless plug for the Southern Investigative Reporting Foundation

I have agreed with and disagreed with Roddy Boyd more than once in the past year. Sometimes I have agreed with him on the analysis but not on the stock. [Insurance scams in particular can take years to unravel - but that does not mean it is not a scam.]

Moreover Roddy wrote the best "narrow" book on the financial crisis. His book on AIG is a gem though extremely narrow focused on one company rather than on the whole global shebang.

Whatever, narrow, deep investigative journalism on financial chicanery is not a highly profitable business. Doing it well is rare.

The Southern Investigative Reporting Foundation (SIRF is Roddy Boyd's baby) is thinly funded - and I think worthy of more. One of his targets has already gone to prison for fraud - and that is reward but not reward enough.

Anyway SIRF has a tip-jar. You know the usual donate-by-Paypal drill.

Tip a little in.

I have.

And if you are an American it is tax deductible. I had to donate out of post tax income.



John

Oil and helicopters

I am reading the annual report from United Technologies - which owns, amongst other things, a helicopter company. To quote:

On the commercial side, Sikorsky finished the year with a backlog of nearly $3 billion — its largest ever — driven by growing demand for offshore transportation in the oil and gas industry.

I am not sure how good that backlog is.

John

Disclosure: no positions. Primarily reading because we have a disclosed position in a jet engine company (Rolls Royce) and like the follow the competition (Pratt and Whitney).

PS. I have received at least half a dozen emails about the hostage drama in Sydney. It is 5km away and I know no more than you can find out from internet. We can see the city from our office though and the number of helicopters swarming around has reduced.

One from the archives: The guy in charge of purchasing acreage at Northern Oil and Gas

Northern Oil and Gas has been a minor obsession of mine for some years and we have remained continuously short.

This is a blog post first published in March 2011 discusses - for the benefit of shareholders - who has been making the major capital decisions for them.

---

Northern Oil is not a traditional oil exploration and production company. It has a simple model. It buys part shares in acreage in the Bakken shale. It waits until the major holder develops the acreage and it pays a proportion of the development costs and receives a proportion of the revenue.

That allows it to be a 1.6 billion dollar company with only 11 staff.

The only expertise it brings to the table is buying acreage. And they buy it at a wide scatter of prices.  They have paid $2500 or more an acre for some small (and presumably productive) lots. For example they paid $2500 an acre for 1748 net acres in Williams and McKenzie County of North Dakota during 4q 2010. They have paid less than 250 an acre for some very large lots. In the last quarter they purchased a 50% working interest in approximately 14,538 net acres in Richland County Montana for less than $250 an acre in the same quarter. In that case the acreage was purchased from the operator (Slawson) and presumably the operator had better-than-average intelligence as to the quality of that acreage.

The supporters of the stock value the stock based on acreage owned. This is obvious enough because you most certainly would not want to value it against current earnings or current revenue.

Given that acreage purchase is the whole reason for owning Northern Oil and believing the Northern Oil story it is worth following the people who manage acreage purchase. Betting on Northern Oil is above all betting on those people.  Northern Oil after all buys acreage in a scatter of prices almost all below $3000 an acre with large purchases below $250 an acre but is valued by the market at about $8600 per acre.  The acreage buying is the driver of incredible (market) value.

So without further ado I will tell you that the Land Manager of Northern Oil is Mr Kruise Kemp. Kruise Kemp has been hanging around the courthouses of Montana swooping on land where leases have expired without ever being drilled. An old article in the Billings Gazette describes the process and says how lease holders in Montana look in envy on the lease holders of North Dakota because in North Dakota the land often gets drilled whereas in Montana leases expire without ever seeing the drill bit. To quote:

Kruise Kemp is no stranger to the courthouses of northeastern Montana. The land manager for Minnesota-based Northern Oil & Gas said there are several buzzing with the land men just like Richland County's. 

Many of those speculators are looking to "top lease," meaning their sniffing out existing oil leases that are just about to expire in hopes of swooping in to strike up a new deal just as the clock runs out. 

In these parts, Montanans, some with leases that went untapped, have looked in envy toward North Dakota where drilling rigs have cropped up like knapweed the last couple years. There are 138 rigs punching holes through the shale in North Dakota. Here, there is only a handful. 

Kemp said the state of North Dakota had provided oil companies with a wealth of services including online field data that made it easy to setup. And drilling rigs attract other drilling rigs. It's a safe assumption when you see other rigs active in your area that you're going to hit something. Having so many rigs drilling in one area puts pressure on companies to permit as many wells as possible before moving on. 

But now companies are turning to Montana to further define the productive area of the Bakken. Working with two other companies, Northern launched a new 3,000-acre project in Richland County this month and has two others nearby.

You see Northern is buying the land where the drills aren't. Of course this makes it cheap. It could be cheap for a reason - the drills not being there because it is not really all that good land. Or it could be that Northern Oil is really great at finding cheap acreage that really is super-prospective.

Well as investors we can't directly know. We don't see the seismic and we are not there with the drill bit.  

All we have to go on in the people. And so I present to you a picture - a couple of years old - of Mr Kruise Kemp.

He played golf for Montana State and was a business school graduate (no particular honors) in the spring of 2010.  A nexus search identifies him as 23 years old.

So what qualifies Kruise Kemp for such a senior role in a 1.6 billion dollar company? Well it is not his finance degree. But Kruise is steeped in the oil industry in Montana. His father owns or controls a couple of oil companies. (I can find their names but not much detail about them.) His late grandfather was also an oilman.

Northern Oil has also done many related party transactions to buy acreage.  If the company is buying acreage from directors then I guess it is incumbent on the land manager to vet those purchases. Kemp is the man with that job.

We view Kemp's age and business degree (rather than say a major in geology or reservoir engineering) with skepticism. Then again we own Google. That is one of the greatest companies in history and it was started by (very bright) people in their 20s. Steve Jobs was 16 when he was introduced to Steve Wozniak and Apple was the result.

It could be that Montana State University business school has produced one of the world's great 23 year old oil-industry entrepreneurs. Might be. As a Northern Oil shareholder that is one of the things you are betting on.

John

Northern Oil and Gas: Michael Reger's deeply misleading tweet

Northern Oil and Gas (NYSE:NOG) is familiar to long-time readers of this blog. I posted about it here, here, here and here.

I have been short this stock for some years and my view is that absent sustained high oil prices this company will file bankruptcy.

I also follow the Twitter account of Michael Reger - the company's CEO.

And he has been continuously retweeting this or variants on it:

In another tweet he says that "$NOG has the most capex flexibility in the Williston. Oh, and we're hedged at ~$90."

Lets check this out. Northern Oil and Gas does have almost 6 million barrels of oil hedged at prices that are $20 in the money - roughly $120 million.

This is against $736 million (at last balance sheet) of long term debt. The hedges are not in the money by 25 percent of market cap - well not really - because the debt holders have first claim. The hedges are in the money by less than 20 percent of the company's debt.

The hedges will thus repay 20 percent of the company's debt.

The company will need to pay the rest by itself from rapidly diminishing cash flows.

Michael - please correct your tweet accordingly.

Moreover Michael pleads capital flexibility. Even that is not obvious. The debt covenants require that the company has a current ratio of 1:1. Currently the company is not close to that covenant. The shortfall (more than 120 million) likely gets subtracted from the available line.

The current ratio short-fall seems to be about the same as the hedge gains. I guess that means they can pay their current liability short fall with hedge gains...

The strange current ratio

Last quarter revenue was about $120 million. Revenue is likely to fall net of hedges.

They have current accounts payable of $220 million.

You may wonder how you possibly have accounts payable of almost twice quarterly revenue (and eight times cost of goods sold).

I will let you work that out.





John