Glenn Tongue is the Managing Partner of T2 Partners and Portfolio Manager of the Deerhaven Fund. Glenn Tongue was a long time partner of Whitney Tilson, until they decided to part ways several months ago. Glenn Tongue presented the long case for JCP, at the Value Investing Congress in 2011. Tilson noted that the company was cheap on an ‘EBITDARP’ basis.
Glenn’s topic of presentation is titled ‘Time Arbitrage’
Below are notes from Glenn:
Glenn Tongue was Whitney Tilson’s partner for a number of years, but recently separeted their investment activities. They still share an office and constantly discuss ideas back and forth. Today Glenn in pitching 2 ideas that center around time arbitrage.
Time arbitrage is created when investors have different time horizons, potentially creating a big opportunity for those with more patience.
First idea: AIG
They pitched AIG at the Value Investing Congress in May, but think the discount today is even greater. Since his last pitch book value has increased 11% but shares are up only 6%.
Today the book value is $66 per share, and shares are trading at .5x book value. He believes in every penny of that stated book value, and thinks fair value should at least by 1x book value.
There remains an overhang or taint from the government ownership. Some investors think used to think the overhang would last years, but the government has moved a lot of stock recently. Government ownership went from 86% at the peak now down to 16%.
Glenn think AIG continuing to buy back shares at .5x book is a great use of capital. He hopes they use every cent of free cash flow to buy back more shares from the government. Recently AIG repurchased $5 bilion in shares when the government divested $21 billion worth of stock
He thinks AIG is actually easier to understand than most people think. When they talk with investors, the common response is they wouldn’t touch it with a ten foot pole. Glenn explains that 97% of AIG’s revenue comes from two lines of business:
Chartis is the property and casual segment, which Glenn believes is undervalued. Today P&C insurers trade for roughly 1x book, but he thinks Chartis is above average and deserves more of a premium valuation. He thinks its worth .9x – 1.3x book value, with BV at Chartis around $48 billion.
SunAmerica is the life insurance and retirement services division. He thinks life is not as good of a line of business as P&C, but that Sun deserves to trade at the top end of industry comparable. He thinks its worth about .7x – 1.1x book value.
Glenn’s total sum of the parts is in the range of $50 to $77, not including the deferred tax assets. AIG has great disclosure due to the recent underwriting, which gives him further confidence in the stated book value. He adds that the derivatives business is in total run off and they did a good job cutting that down.
Today the company is extremely conservatively capitalized. He thinks over time they can add more leverage as they transition from defense to offense. With the overhang of the US Treasury nearly gone, the institutional taint should fade.
Glenn thinks the 75 million warrants AIG issued that expire in 2021 are a compelling way to investing in the company. These are not TARP warrants, but have many of the same features. If AIG grows book value at 6-8% per year, and the stock is valued at book value, the warrant offer potential for an 8x return. Investing instead in the stock offers potential for a 4x return under the same assumptions.
Management succession is a risk, along with the volatility along the way. However the opportunity to pay $.50 and receive $1 worth of a strong global franchise is very compelling.
Idea #2: Iridium (IRDM)
Glenn loves this business, its is growing quickly and has a huge moat. After going public through a SPAC, shares have decreased to a level that provides a great opportunity.
Note: yesterday in Tilson’s presentation he mentioned at IRDM was a major reason T2 underperformed in Q2 2012
IRDM is trading at 5.9x EV/EBITDA, versus competitors that trade for 9x – 10x EV/EBITDA. He thinks this is a strong industry that justifies that type of valuation.
IRDM is the only provider that can provide real time voice communications over 100% of the earth’s service. This is a niche product that not everyone needs, but governments and travelers do. The Department of Defense is a core customer of IRDM.
The Mobile Satellite Service (MSS) is growing nicely, mid-single digits growth. IRDM has 66 satellites, all of which are much closer to the globe and smaller than standard satellites. This architecture helps with the speed of IRDM’s telecom service. Glenn believes IRDM is well positioned within the MSS market, where they specialize in mobile.
IRDM is a service provider, they just focus on driving more network revenues. IRDM has 300+ partners out focused on driving innovation. Recurring service revenues drive value, and margins are extremely high on the network side. Equipment sales and engineering is a component of revenue as well, but Glenn is really attracted to the network revenues. He believes as IRDM grows, network will become a bigger portion of their business which improves the overall margin mix.
Funding comes from three different areas: internal cash flows, debt, and the recent equity transfer. He thinks the debt on the company will top out at $1.4 billion, and investors don’t give IRDM enough credit for their strong cash flows from operations. The company should be able to use those cash flows to dramatically pay down debt, serving as a catalyst. Glenn thinks they should be able to generate $18 billion in incremental revenues from their recent $3 billion capex program.
The Aiereon project focuses on satelitte intelligence for airplanes. Glenn thinks Aiereon will aid the aircraft industry by enhancing safety and cutting down on fuel costs as more planes can utilize the gulf coast winds.
The issue with the stock was the open ended $100mm equity raise the company announced earlier in 2012. According to Glenn this was a short sellers dream and was a huge stumble by management. But last week this was fixed when the company issued $100mm in convertible preferreds and an exchange offer for outstanding warrants. With these two transactions overhang is removed and now the capital structure is simplified.
Since this announcement, the stock has had a lot of pressure from convertible arb traders. Glenn thinks this is a short term trade and those pressures will equalize out. He thinks the implied stock price in 2016 is $17 – $25. He believes IRDM will compound at high rates for a number of years, using strong cash flows to pay down debt in the process.
2:32 EST: Q&A
In the first question, an investor in the crowd shares his bad experiences when he relies on the government for due diligence. Glenn explains that he isn’t trusting the government on AIG, but instead that there is so much material out there on AIG, that investors can understand it at a much more detailed level than comparable businesses.
Tilson adds that many investors write off the larger banks and insurance companies as “black boxes”. He thinks that is an opportunity, because companies like AIG are so scrutinized by the government that there is plenty of material to dig into.
Glenn adds that AIG’s insurance operations are great worldwide franchises, and are much more respected outside the U.S. Competitors claim that AIG is not good at underwriting, but Glenn’s work on the reserves gives him confidence.