Investors are asking, "Is this 2008 all over again?" Our answer is, "No." Here are some of the reasons:
- The U.S. financial system is much stronger today than it was 3-4 years ago. The slow motion train wreck in Europe is widely anticipated and should not create the same kind of liquidity crisis as the failures of Lehman Brothers and AIG;
- The U.S. home building industry and the housing-related businesses that collapsed several years ago are on the mend—that bubble has already deflated. While the recovery is unfolding painfully slowly, the direction is positive and housing should be a positive factor going forward rather than the significant negative it was in 2007 and 2008;
- Even if global economic growth remains sluggish because of western government austerity moves, Chinese efforts to curb inflation, etc., many companies are finding ways to grow their businesses and increase per share values for their shareholders.
Wells Fargo ($24) continues to aggressively reduce its exposure to non-performing mortgage loans of its own creation and troubled loans inherited in its acquisition of Wachovia. The volume of loans entering the workout pipeline is shrinking and the number of loans exiting that pipeline is increasing. Loan loss reserves have proven to be more than adequate and some reserves are being "released" into earnings. Wells does not have the same exposure to derivatives and European sovereign debt that some of the other major U.S. banks have. Wells does have an enormous pool of low cost deposits, and as loan demand returns and interest rates rise, its earnings and dividend should grow. We expect Wells to earn at least $4 per share within a few years and our current appraisal is $34.
Redwood Trust ($11) is another financial company with excess capital in search of attractive investment opportunities. Redwood survived the mortgage meltdown and has the capacity to be a significant lender in the prime jumbo mortgage market (mortgages larger than those guaranteed by Fannie Mae and Freddie Mac). Redwood is the leader in its field and is patiently building its capacity to take advantage of a very large opportunity as the housing industry recovers and financing competition from government-sponsored entities decreases.
Some companies are using changes in their capital structure to increase value. Tyco ($41), having spun off its electronic components and medical products businesses several years ago, has just announced plans to split the company into three parts: North American residential security (ADT, Brinks), flow control products and commercial fire and security. Each of these businesses has different financial characteristics and will likely find different shareholder constituencies. Our estimate of the value of the combined Tyco entity is $65 per share and we expect the split into three companies to help shareholders realize full value.
Liberty Interactive ($15—QVC and several online retailers—our value $20) is being separated from Liberty Capital and Starz, and we expect it to be more valuable on its own than as one of three Liberty Capital "tracking stocks." Aside from focusing management attention and providing a "pure play" on QVC for shareholders, a standalone Liberty Interactive may choose to follow the Liberty Global pattern of taking on "prudent" amounts of debt and doing aggressive share buybacks. This has the potential to magnify the value of the shares.
SandRidge Energy ($6—oil and gas exploration and production) is taking advantage of the very low interest rate environment and retail investor interest in "yield" to place minority interests in some of its properties into royalty trusts to be sold to the public. This provides relatively low cost, non-debt financing for carrying out its drilling program. Ultimate profitability of their business depends on oil and gas prices over the next several years. We think the odds are very good that SandRidge (and our other energy companies) will produce reasonable returns over the years, and they provide the possibility of providing pleasant surprises if energy prices rise more than expected.
You can read his full letter here.