Monish Pabrai Post-Mortem on His Best Ever Investment – Teck Cominco (TCK)
The second business I want to talk about is Teck Cominco (TCK), which is now called Teck. Teck is a well managed company based in Canada, and is one of the largest miners in the world. You can think of it as the IBM (IBM) of mining. It's one of those stocks for widows to own. You hold it forever, with very solid, continuous and regular dividend streams, and solid growth over the years.
We invested in this stock right at the heart of the financial crisis in December 2008. We manage over $500 million in capital right now, but at that time in 2008, we were managing just $200 million. Teck was a situation where there was a slightly elevated risk of a loss, but an outsize return if we didn't have a loss.
This was a basket bet where I put about 2 percent of the assets into a number of different investments that were highly correlated. We invested about $4.4 million into Teck between the three funds. We bought at the absolute bottom of the financial crisis at $4.50 a share and I sold the last of it in the first quarter of this year for about $36 a share. We had about a 763 percent return, and we made about $38 million. It's the highest return we ever had in any investment in Pabrai Funds over the 11 years that we have existed.
Teck has copper, coal and zinc mines. It's one of the largest mining companies on the planet along with BHP, Rio and Vale. Teck is a low-cost producer and has some of the lowest cost mines on the planet. They are also a dominant miner of metallurgical coal. Metallurgical coal is fundamental to producing steel. Teck saw a huge opportunity in the growth of metallurgical coal demand over the years. Their thinking is probably right on.
One of the things I believe will happen is that we'll probably see the rise of at least 100 brand new cities if not more, over the next 20 or 30 years which will each have at least 5 million people. When you are going to build out 100 New Yorks in a 30-year period, you can't do that without steel.
There are particular nuances with met coal where it's not a commodity. For example, if you have a particular steel mill in China which uses coal coming from Canada, they can't switch it suddenly to using a coal coming from India without doing a lot of re-engineering through their furnaces and machinery.
There are some specific chemistry nuances with met coal. Metallurgical coal and iron ore are both chokepoints. Most of the iron ore going to China comes from two countries, Brazil and Australia, and little bit from India. They're the chokepoint in terms of China's ability to get iron ore. Metallurgical coal is the same way. The management of Teck saw a huge demand coming for metallurgical coal and they wanted to increase the metallurgical coal capacity.
Tech owned 60 percent of Fording Coal which has a very large metallurgical coal operation. They offered to buy the 40 percent they didn't own. The markets liked that deal. When Teck announced the deal to buy the rest of Fording, the acquiring stock price went up almost 20 percent. Teck's stock price went from $35 to $42 a share when the deal was announced.
This was very unusual. Normally when a company's making an acquisition, its stock price drops, and the target company's stock price rises. And Teck did something very unusual for the time. They did most of this deal with debt, and they did it with a one-year bridge loan. Because they wanted to get the deal done, they organized about ten billion in a one year bridge loan type facility to close the deal. They planned on going out to the debt and equity markets, and then raise debt through long term bonds to pay off the bridge loan and clean up the capital structure.
They closed the deal in 2008, but in the 2nd half of 2008 everything went downhill. Lehman Brothers goes bankrupt. There are no deals to be done on the debt market and the debt markets close. Suddenly, the markets start looking at the wall of debt that Teck has to pay back in 12 months. It clearly outstrips their cash flow, and at the same time, the commodity prices are in freefall.
The big concern was that if Teck could not handle their debt in a year, they would have to file for bankruptcy. Teck was looking at massive debt coming due. Within a year, all the commodity prices had collapsed. Their cash flow projections were out the window. The stock went from $50 a share to $4 a share in just a few months. That's when we started to first buy the stock.
On the balance sheet, Teck had a lot more assets than liabilities. They had a liquidity mismatch. They had enough assets to pay off all the liabilities, but those assets weren't liquid. The markets were concerned that when the debt came due, Teck wouldn't be able to pay the debt, and they would have to file for bankruptcy. When I looked at the whole thing, I thought that even if they filed for bankruptcy and even if they went through a bankruptcy reorganization, the equity would still have value because there was so much more in assets versus debt.
A similar situation happened recently with General Growth (GGP). General Growth is a very large mall operator. They have a huge amount of illiquid assets in their very valuable prime properties, but they didn't have the cash flows and the liquidity to service their debt. In General Growth's case, they went bankrupt, but when they came out of bankruptcy, the equity did not get wiped out. I saw the same thing in Teck. Even if they went bankrupt, I didn't see the equity being wiped out.
At the same time, I felt that the odds that Teck would file for bankruptcy were very small because they had many levers that they could pull. They could cut the dividend that they were paying. They had gold mines and other assets that they could start selling. They had some hedges in place so some cash flow was guaranteed. They had a whole bunch of assets they could sell piecemeal to different bidders. I also felt that they might see a little bit of a bump in commodity prices.
Finally, the top Canadian banks were holding the debt and they have no interest in running a mining company. The Canadian banks could do what has been done with a lot of the commercial real estate in the U.S. They extract a pound of flesh, and do what is known as "extend and pretend." The banks could go to Teck and give extensions on their debt with some higher fees, penalties and covenants.
I didn't think that the banks would push them into bankruptcy. I thought the banks would negotiate with them, and then commodity prices would lift from the severely depressed levels. If the company didn't go bankrupt, then this was a straight 5 to 7x gain. Teck's management executed brilliantly. They cancelled the dividend. They went through and sold a bunch of tertiary assets. They got the loan extensions from the banks. They issued equity to China Investment Corp. They juggled through a whole bunch of things over that one-year period.
As that overhang lifted, the stock pretty much started to go back to where it was, from under $5 a share to over $40 a share in ten months. The mid-$30 a share approaching $40 a share was pretty close to my assessment of what the business was worth. We held Teck for only 13 months. We held to get long-term gain, and then we were done.
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Monish Pabrai (Updated on 05/22/2013)