Erez Kalir on MBIA and Argentina at Ira Sohn Conference

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May 25, 2011
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Erez Kalir is CEO and co-founder of Sabretooth Capital, a New York-based hedge fund focused on finding asymmetric investment opportunities across asset classes globally. He previously worked at Eton Park, McKinsey & Co., and in three branches of the U.S. Government. Erez holds an A.B. (highest honors) from Stanford University, an MSc. (highest honors) from Magdalen College, Oxford, where he studied as a Rhodes Scholar, and a J.D. from Yale Law School, where he was a senior editor of the Yale Law Journal.

From his talk:

Economic Death as Special Situation

Warren Buffett ’s way is a lot harder since he started in the 50s. Lots of people trying to imitate him nowadays.

Economic death might be a better way.

Economic death can fall into entire industries or countries through depressions, hyperinflation.

When this happens the real return changed.

Twain: “The rumors of my death have been greatly exaggerated.”

When an entity faces an economic death and the animal spirits are sure of death and you look into the fundamentals and realize the market is wrong, you can make a great profit even if the company is garbage.

Sometimes the market also underestimates economic death.

There are two examples.

1. MBIA was a boring insurer that insured muni-bonds that changed its strategy. Bill Ackman came along and through a brilliant presentation showed this. The catalyst was the financial crisis. However, now the market is overestimating death.

Three reasons:

Legal risk is not assessed by the market well because it involves reading through thousands of pages, but we have done all that. MBIA separated its good assets from bad assets, which is being challenged, which we think will fail. Even if litigation succeeds we don’t think they will be forced into receivership.

Shorts are scared of legacy structure risks. If litigation fails we do not have to worry about this. Also, the open source model is outdated and no one has tried to update it. We fixed an important methodological flaw which failed to take into account PV and FV. It turns out the multi-sector CDs and MBs are much smaller, and have a much smaller chance of driving it into bankruptcy. We also think there is a large margin of safety.

Finally, the company’s involvement in the muni-market has a chance to blow up the company. We agree that states are facing huge problems.

MBIA is trading at one-third of market value. We think the stock should have 100-200% upside. If you get this wrong though you risk a large loss of capital, so you need to be careful how large a position it is.

Second example is Argentina. Let us think back to the 1900s and compare Argentina to the U.S. It probably would have been a toss-up which country would be the world leader. But in 2002 Argentina made the largest default in history.

Argentina made huge mistakes over the 100 preceding years. The market still sees Argentina as a failed state. The CDS spreads are way above most of Latin America. Most of their neighbors are embracing serious economic reform. The elite of Argentina plan on copying this success.

The best way to play that is the E&P center. The country has enormous oil markets, and since it was once developed it has a first-rate energy sector. But for its entire history, Argentina has been a net exporter and used price controls for domestic needs. It is now needing to deregulate policy and this will make the E&P sector much more attractive.

We think Crown Point Ventures (CWN), and YYPF S.A. are attractive.

Even the most sophisticated investors do not always consider economic death enough. When a country falls below… George Soros calls it a doom loop. The U.S. is at risk of falling into that trap. The Federal Reserve has signaled it wants to create inflation but too confident to control it.

But what will happen? This would cause economic death, like in Argentina pre-2001.

Best hedging strategies include gold. It is subject to economic confiscation. In 1961 Kennedy made international ownership of gold illegal, and owning gold in Switzerland as John Paulson is doing will not help.

My mentor Julian Robertson is shorting treasuries. Both are subject to financial repression, when the government tells you what classes you can own.

Last is to own dominant stocks with pricing power. However, in true hyperinflation there is capital flight from all financial assets. Even JNJ and BRK does not offer protection.

The one way to hedge is by buying farmland.

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