Let’s start with a disclaimer here. I’m not a professional pollster. With few exceptions, most of the professional pollsters are on the opposite side of this trade. I’m a contrarian and that means I am bound to get a few of these wrong.
Q3 2020 hedge fund letters, conferences and more
With that disclaimer out of the way, the early voting data shows Trump with a small lead and as the days have gone by, the voting has consistently turned “redder,” while the remaining potential voter pool shrinks. Nothing is a sure thing in elections, but I see independents swinging for Trump and there’s a surprisingly large net wobble amongst Democrats. I have spent a lot of time going through the data and don’t want to focus this article on the minutiae of numbers (especially as I may have interpreted it all wrong). Instead, let’s talk about my passion; setting up a low-risk, high-reward, Event-Driven trade, with a view that Trump likely has this one in the bag and everyone is leaning the wrong way.
I always start this process by asking what happened last time. Last time, I also called it right. I was short S&P futures in size and short even more through notional put spreads. I covered on limit-down (actually my wife did, as I was out celebrating) and reversed max long. This time is different, both candidates support Project Zimbabwe, so we must focus on the individual names as opposed to broad market indexes. Who benefits from a Trump win? Ironically, it’s probably the same guys as last time.
A whole lot of people are suddenly paying attention to BLM…
CoreCivic (CXW)
My biggest Trump play is CoreCivic (CXW – USA), owner and operator of prisons. Government is synonymous with waste and incompetence, hence why many government functions have been outsourced over the years—everyone wins, which makes outsourcing into a bipartisan issue. Over the past decade or so, the Democrats have turned against private prisons. I don’t want to debate the issue, but it’s worth understanding that private prisons are no longer bipartisan.
CXW is something of an oddity as an Event-Driven play since it’s undergoing multiple headwinds simultaneously. To start with, the folks who craft the ESG rules are also against private prisons, so funds are being forced to sell CXW and there is some question on if CXW will have future access to debt funding. It hasn’t helped that CXW made a decision to cease being a REIT as of the first day in 2021, leading multiple REIT ETFs and institutional REIT owners to become sellers, while the retail crowd formerly attracted to the double-digit dividend yield was shocked when the dividend was cancelled. Any one of these could set up an attractive Event-Driven trade and the multi-catalyst overlap has made CXW into an unusually coiled spring. It’s said that when someone yells “fire” in a burning theater, I’m the only fool who runs towards the fire. CXW is one such a fire with multiple layers of indiscriminate selling and a Presidential candidate who wants to ban the business.
Now, let’s look under the hood a bit. To start with, Obama talked a big game about closing Guantanamo, but realized that it was a lot harder than he thought—some people really need to be locked up in prisons. Actually, private prisons did just fine under Obama. Pulling away another onion layer, CXW operates with long-term government contracts. A President cannot simply cancel these contracts, especially as so much of the prison infrastructure was outsourced to private operators and there is nowhere to put these inmates. Finally, a good chunk of the business is done at the state level, a venue where Presidents have less power. The only place for real interference is on the ICE contracts which are tied to inmate populations. Even on the ICE contracts, I suspect that a Democratic President opening the border will lead to more criminals crossing and a potentially higher ICE population. Societal trends towards sentencing reforms and decriminalizing various drugs are likely to be bearish longer-term secular trends, but that’s beyond the purview of this election play. In summary, a candidate can say scary things, but Guantanamo shows how gradual the process will go in reality. Meanwhile, CXW at $6 trades at roughly three times normalized AFFO. CXW is cancelling its REIT status in order to de-lever and then repurchase shares. From a capital allocation standpoint, this makes rather strong sense.
I don’t know what the right multiple on real estate with long-term US Government counter-parties is, but in a ZIRP world, it should be a whole lot higher than the current quote—especially as the business is slowly moving away from operating prisons, to a model where CXW instead leases them to government agencies on fixed-price long-term leases. This was a stock trading in the $20s just 18 months ago. I suspect it will make it at least into the teens on a Trump victory. You only have to look at 2016 to see some precedent as the stock more than doubled. I’m not much of a call buyer as I hate paying for premium, but I’ve also lifted an unusually large number of November OTM calls here.
Look at that chart as EBITDA stayed constant and the multiple compressed into this election (sorta like last time). Then BOOM!!
Alliance Resource Partners (ARLP)
Where else have the Democrats focused? They absolutely hate thermal coal. I can’t have a Trump spread without one coal play and I’ve chosen Alliance Resource Partners (ARLP – USA). ARLP is the lowest cost diversified domestic thermal player and throughout the bear market, they’ve consistently produced cash flow. Insiders own almost a third of the company and as a result they’ve ran ARLP with reasonably low leverage. Finally, ARLP also has a growing oil and gas royalty business which is likely worth a good chunk of the market cap. In any case, while Trump rolled back some regulations, he was no savior of thermal coal as low natural gas prices pushed many mines out of business. That said, I’m unusually bullish on natural gas here. After over a decade of natural gas production growth, production will comp negative in 2021, at a time when demand is still growing. This is a recipe for higher natural gas prices. Coal should do extra well as not only will the realized price increase, but tons sold should increase as well, leading to operating synergies and lower costs. ARLP trades at roughly one times FCF after maintenance spending, which means there’s a good deal of upside in a world where natural gas is in the $3s or higher. A year ago, the shares traded in the teens and I assume they can go back there with a benign regulatory environment.
Of course, when I look at Event-Driven trades with a clear catalyst, I want to protect my downside. I don’t see any President banning coal. You can’t charge your EV without baseload power and California is learning that the hard way. Instead, I expect an increase in operating costs and taxes to use coal. It will be a gradual extinction event, not an asteroid hit. At the same time, back when Biden was still capable of uttering full sentences, he was pretty clear about banning fracking. I can see a lot of scenarios where less gas production actually leads to more coal production as you have a perfectly permitted coal mine but cannot permit a new well. Besides, cause and effect isn’t a strong suit for most environmental types. In any case, I own a whole lot of ARLP as well.
In the case of CXW and ARLP, I’ve tried to set up trades with the election as a clear catalyst and a situation where the stocks are already so beaten down that a lot of the worst-case scenario should be priced in, while a Trump victory should give me multi-baggers in short order. Finally, I’ve selected companies that are somewhat insulated if I get it wrong, because history says I’ll get it wrong plenty of times. Like all Event-Driven trades, I’m playing the odds and with a big enough sample set, the odds are very much in my favor, especially as the data increasingly says that Trump wins this one.
On a final note, I’ve always ran this site as a way to crowd-source ideas. I have a growing basket of “Trump plays,” but I’m sure I’ve missed my fair share. I’m not looking for a small pop or a view on interest rates. Rather, I’m looking for the next Fannie Mae (FNMA – USA) that tripled on the last Trump win. If you have ideas, please email me at [email protected]
Disclosure: Funds that I control are long ARLP and short ARLP puts, long CXW, long CXW calls and short CXW puts.
Article by Adventures In Capitalism
