Thursday, November 15, 2012

Great Northern Iron and the persistence of worthwhile counterparties

Great Northern Iron is a funny traded instrument. It is a trust. The trust expires on 6 April 2015 when they will have one final cash payment and go to zero.

This is not controversial. The trust explains this on its website:

At the end of the Trust on April 6, 2015, the certificates of beneficial interest (shares) in the Trust will cease to trade on the New York Stock Exchange and thereafter will represent only the right to receive certain distributions payable to the certificate holders of record at the time of the termination of the Trust. Upon termination, the Trust is obligated to distribute ratably to these certificate holders the net monies remaining in the hands of the Trustees (after paying and providing for all expenses and obligations of the Trust), plus the balance in the Principal Charges account (this account is explained in the Trust’s Annual Report within the Notes to Financial Statements). All other Trust property (most notably the Trust’s mineral properties and the active leases) must be conveyed and transferred to the reversioner (currently Glacier Park Company, a wholly owned subsidiary of ConocoPhillips Company) under the terms of the Trust Agreement.

The exact final distribution, though not determinable at this time, will generally consist of the sum of the Trust’s net monies (essentially, total assets less liabilities and properties) and the balance in the Principal Charges account, less any and all expenses and obligations of the Trust upon termination. To offer a hypothetical example, without factoring in any expenses and obligations of the Trust upon its termination, and using the financial statement values as of December 31, 2011, the net monies were approximately $7,927,000 and the Principal Charges account balance was approximately $4,962,000, resulting in a final distribution payable of approximately $12,889,000, or about $8.59 per share. After payment of this final distribution, the certificates of beneficial interest (shares) would be cancelled and have no further value. It is important to note, however, that the actual net monies on hand and the Principal Charges account balance will most likely fluctuate during the ensuing years and will not be “final” until after the termination and wind-down of the Trust. The Trust offers this example to further inform investors about the conceptual nature of the final distribution and does not imply or guarantee a specific known final distribution amount.

The only thing that unit holders in the trust are entitled to is dividends between now and April 2015 - plus a final termination payment.

The "stock" trades are an amount higher than any amount of dividends likely to be received. It is thus an obvious short and many people have written about it (notably including Citron). Here is a typical example.

This is all well known. Buy this "stock" and you are nearly guaranteed to lose money.

Because that is so well known the stock has a 20 percent borrow cost - roughly offsetting the profit you will get from shorting it. In that sense there is a rational market.

But that is the only sense there is a rational market. People own this. They will lose money. Ponder as a might I can't think of who the suckers might be.

Except one group. Computer driven trading firms. They see the high profits (iron ore prices are not low yet) and the 18 percent dividend yield and the algorithms tell them to own this. Maybe them and some really dumb dividend chasing retail investors.

This should distress me - but it doesn't. I like ill informed people making stupid investments in the market and their persistence pleases me. They have a name: counterparties. May there be many more of them!



Tom said...

Yeah, Andrew Left wrote about this one some time ago on the Citron blog. He called it a stock that only a computer can love.

The other trust that he mentioned at around the same time is WHX. This one is even more fun, because the price has already collapsed to *below* the expected PDV of expected future payouts. A naive trader might think that there is an arbitrage opportunity here, but there isn't.

You see, if you own WHX during a distribution, then you have to file a tax return in something like 8 states! Thus, fair value *should* be less than the PDV of expected future payouts, just because of the tax headaches.

I wish more stocks would "bury" things in public view in their 10-K, to give an informational advantage to real investors rather than computers. You know how Garry Kasparov used to play "anti-computer chess," where he'd deliberately play in a completely different style, because he knew that the computer had been trained on his previous games? I wish there were more "anti-computer stocks" available.

Anonymous said...

If you own it and can lend it out at close to 20% pa it's probably not a bad investment - so these holders doing the lending might be rational

Alex said...

I think GNI is an example most of all about how much harder hedge fund investing has become because in the old days not as many people were chasing borrows like this and it would have been profitable to short.

Nick said...

Usually it is the banks/prime brokers who take the lending fee not the underlying holders.
Underlying holders just give them permission to lend (or not).

Anonymous said...

With a borrow that high a sophisticated institution could definitely capture some of that yield. Dividend chasing retail investors not so much.

Anonymous said...

So brokers have an enormous incentive to hawk it to muppet clients, and then lend out the security to shorts. Yeah?

dede said...

I scratched my head reading "will generally consist of the sum of the Trust’s net monies (essentially, total assets less liabilities and properties)"

Thought it was a typo, then a scam to keep the properties. Going on the website, I understand the rationale in 1906. Looks like the company scheme is clean and, yes, anyone holding it and not selling at current price is dumb (even if he can lend it because lending should help the price go down to its real value minus a discount for the risk)

Looking at volumes and trading range advertised on yahoo, it looks like there is a lot of dumb money around.

Thanks for the post, I started to miss your articles.

Hayden said...

Not sure it applies here, but often index funds also have to hold stocks regardless of the fundamentals (although not sure if there would be any niche indexes where this may fall into).

Anonymous said...

I wouldn’t be so sure it’s computer driven trading. Could mum and dad investors cause the issue? A similar thing happened with Australian listed Bass Strait Oil and Gas Trust. In early 2000, three years into its ten-year life, it was so cheap that the NAB-guaranteed capital returns alone made for an extremely attractive investment – you couldn’t lose even if oil production and oil price went to zero. Four or five years later, with just a few years left on the security, it was similarly overpriced in a higher oil price environment (can’t remember the exact details). Over those last few years, in my job I must have answered a dozen or more queries from retail investors attracted to the apparent 20% (or so) yield and apparent exposure to higher oil prices. They were all shocked when I told them it would be worth zero come 2007. I don’t know whether the retail yield-chasing weight of money is enough to drive the price up, but I doubt it was computer models causing the overpricing around 2005 in BSO.

Anonymous said...

Surely this depends on what sort of capital gains tax position that you have? You can use the capital loss and get the income-anyone shed lioght on this?

The Rioja Kid said...

John, who's making the 20% return on the borrow if not the owners? If that return is equal to the premium as you say, then you can buy this stock and either make or lose money dependent on what happens to the iron ore price. Any quant fund buying it is certainly going to be lending it out, so it is only the widows & orphans who are getting done.

Anonymous said...

what quant funds look at fundamentals anymore? most of them are 'market neutral' who arb out micro-mili-second deviations. Or try to sniff out a big order coming down the pipeline.

Speaking of robots: it took me 5 times to post this because of the anti-robot phrase tester.

srp said...

There is a literature in experimental economics showing that securities just like this one reliably produce bubbles above fundamentals in laboratory trading games. Interestingly, the players who stick to the fundamentals are not the ones who make the most money; the biggest winners (and losers) are the "greater fool" investors who try to time the bubble.


tiru said...

:D Had it on my screener since the post. And finally, some sense in the market.

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