Considering BMC Software Bonds For 11% Yield

bmc_software128BMC Software (BMC) is an IT management company based in Houston, Texas, that was that was acquired by private equity firms Bain Capital and Golden Gate Capital in September 2013 for around $6.9 billion. BMC Software’s main competitors are CA Technologies (CA), IBM (IBM) and other large technology companies. Many of its businesses, including in particular its mainframe business, are characterized by high switching costs, low customer turnover and high recurring revenues. It has been a stable business, and that’s why it was a great target for a leveraged buyout.

The LBO was financed by equity contributed by the sponsors and debt, including a $350 million revolving facility, $2.9 billion, $335 million and Euro 500 million term loans and $1.6 billion senior notes. The $1.6 billion senior notes mature in 2021, pay 8.125% interest and currently yield around 7.5%.

So how is a retail investor like you or me able to participate in this transaction? We can’t buy the bank loans and the $1.6 billion of senior notes were only sold to qualified institutional buyers. We obviously can no longer participate in the equity of the company. So where does that leave us?

The interesting thing about this LBO is that it also involved a tender offer for BMC’s outstanding SEC-registered notes. Although most of the outstanding notes were purchased in the tender offer, a small amount was not, and those notes are still outstanding.

4.25% Notes Due 2022 (Cusip 055921AB6)

4.50% Notes Due 2022 (Cusip 055921AC4)

BMC originally issued $500 million of the 4.25% notes and $300 million of the 4.50% notes in 2012. Around $454 million of the 4.25% notes and $270 of the 4.50% notes was repurchased during the tender offer in connection with the LBO, leaving around $46 million of outstanding 4.25% notes and $30 million of outstanding 4.50% notes. As a result of the additional leverage incurred in the LBO and the amendments made in connection with the tender offer/consent solicitation, these notes now yield around 10.5-11%. Here are two charts showing the yield and price history and the impact of the LBO on the 4.25% notes and 4.50% notes.

My view is that if BMC is able to refinance its $1.6 billion of senior notes due 2021 by their maturity date, then it will very likely be able to refinance the $46 million and $30 million of notes due in 2022. That amount is almost immaterial in the context of the overall debt incurred in the LBO. There may be a different recovery analysis between the bonds in an insolvency scenario, but it seems that the refinancing risk is more or less the same even though the 2022 notes mature after the 2021 notes. Consequently, although I encourage you to do a full covenant recovery analysis, the $1.6 billion notes due 2021 and the 2022 notes should trade around the same yield.


But all things aren’t equal between these notes, and one of the major disadvantages of the 2022 notes is a lack of liquidity driven by the small amount of outstanding notes. If the market drops or trading dries up, it will be difficult to unload the 2022 notes. However, you are being more than adequately compensated for the lack of liquidity, in my opinion. These notes are more or less just as likely to be repaid as the $1.6 billion notes due 2021 and pay an additional 3.0-3.5% per year of yield. If you are willing to buy and hold, the additional yield can provide significant additional return.


BMC is no longer an SEC reporting company so its results are not publicly available. To review the results you will need to access their investor site. If you are interested in purchasing these notes I encourage you to review their results and risks, which are beyond the scope of this post. This is a highly leveraged company and the ascension of the public cloud may represent serious risks. Nevertheless, I think there are a lot of reasons to consider these for a position in the portfolio.

Is The FTC Finally Taking The Herbalife Allegations Seriously?

a061f166f8ceffece1bce9cf67427e38The FTC announced today that it plans to hold a press conference on Tuesday ”against deceptive advertising of weight-loss products” made by national marketers of “fad weight loss products.” Herbalife was down 3.5% on the news.  I hope this is early signs that the FTC is going to take on the various pyramid schemes out there that are exploiting millions of young people with “get rich quick” schemes that involve no real retail opportunity. Unfortunately, I don’t think that’s what this press conference will be about, but the use of the word “fad” makes me a bit more hopeful that the FTC will take its job more seriously and require proof of actual retail sales to third parties (and not just personal consumption, which is just a ridiculous excuse for the obvious lack of any real retail sales to third parties).


Unfortunately, I think it’s more likely that the FTC issues some token harsh words around marketing weight loss products but doesn’t actually do much of anything next week.  It’s much more likely that State AGs and the plaintiff’s bar are the ones to force pyramid schemes like Herbalife to demonstrate actual retail sales and defend themselves against fraudulent misrepresentations to new members.  Hopefully I am proved wrong and the FTC steps up.

Angie’s List Volatility

icon_256Angie’s List (ANGI) is down 11.5% so far today, after trading up 6.4% on Tuesday.  All on no news other than a class action lawsuit (which apparently cites a Seeking Alpha article).  I am effectively short so no complaints but this does not look like a very strong case.


Here’s the plaintiff’s argument:


The complaint alleges that during the Class Period, Angie’s List issued materially false and misleading statements regarding the strength of the Company’s business model and its financial performance and future prospects and failed to disclose the following adverse facts: (i) Angie’s List had increased its reliance on providing free memberships in order to artificially boost its subscriber figures; (ii) contrary to Angie’s List’s repeated Class Period statements that the online reviews were unbiased because Angie’s List did not permit service providers to buy ratings on its website (“You can’t pay to be on Angie’s List”), the Company was consistently deriving more than half of its revenues from the service provider side of its business – where it relied heavily on collecting fees for listing paid service providers more prominently; (iii) because Angie’s List sometimes charged service providers hundreds of dollars for “hot leads,” those costs were being passed along to Angie’s List subscribers, increasing the prices consumers were paying and decreasing the benefit to them of using the website; (iv) the legitimacy of the service provider side of Angie’s List’s business model was called into question by Angie’s List’s practice of forcing service providers to pay high fees to be listed as highly rated service providers, knowing that if they did not, they would not get customer referrals from Angie’s List; (v)  because Angie’s List did not vet the service providers listed and recommended on its website, either for qualifications or for safety, many consumers were questioning the value of its recommendations, making them unwilling to continue paying outsized membership fees; and (vi) as a result of the foregoing, Defendants lacked a reasonable basis for their positive statements about the strength of Angie’s List’s business model and its business and financial prospects during the Class Period.


In other words, ANGI has a bad business model that relies on convincing customers that it is impartial and provides a valuable way to find the best service providers when in reality ANGI earns most of its revenues from service providers.  But that just means that it’s a bad business model, not that management made any material misstatements.  This looks like a weak case.


Apparently the suit also cites a Seeking Alpha article.  As a fellow SA contributor I am a bit speechless – particularly since I tried to point out that the author’s argument that unearned revenue is a real liability that they cannot satisfy is not a good argument so long as ANGI can continue to bring in new prepaid sales.

Why Do I Own Yelp In A Portfolio For Future Dividends?

yelpThat’s a good question I have asked myself. It’s definitely outside of my core portfolio strategy of looking for doubles and singles. Yelp is probably either a home run or a lousy investment. I think it will be a home run. Here’s why.


Opportunity to be the “Yellow Pages” of the Internet

There is tremendous opportunity here to become what the Yellow Pages offered, but then so much more. The market is obviously huge, with 1.3 million businesses having claimed their Yelp businesses versus 53 million total businesses in the US, Western Europe, Canada and Australia. There simply needs to be a convenient way to find a restaurant, plumber, doctor, hair stylist, etc, online. But more than that, there needs to be a way to transact with those businesses by booking an appointment, ordering delivery, getting quotes from wedding photographers, etc. The reviews give the site the content people need to evaluate the business, and it’s up to Yelp to create the tools to transact with that businesses.


In my view, either Yelp or Google will be the go-to place for finding, evaluating and transacting with local businesses. Google obviously has many advantages, including most importantly Google Maps. But my view is that the function of finding, evaluating and transacting with local businesses is sufficiently difficult that the winning service needs to be tailored completely for that purpose. Google is not able to devote a service/app directly to that function; rather it is integrated into the Google search and Maps functionality. For example, Google Maps is used for so many different purposes that it can’t be tailored specifically to finding a cheap burger joint in a 5 block radius in Manhattan. Yelp can be and I think that matters. Particularly for smartphones where I think there needs to be an app dedicated to this function. When someone needs to find a plumber, I think the winning model is going to be to open an app dedicated to that function. Otherwise there is both too much and too little information.


Plus, a review site needs to be fun. For whatever reason, Yelp is fun and Google Places is not. That means that Yelp gets real, valuable reviews and Google links to one-liners from its Zagat acquisition.


It’s going to be a long battle between Google and Yelp but I’m betting that the dynamics here favor the dedicated functionality versus the search and smartphone operator. At least until Google throws in the towel and buys Yelp…


Will Yelp Ever Pay a Dividend?

Maybe. I know it sounds crazy, but if this company succeeds and becomes an internet “utility” for finding, evaluating and transacting with businesses, then you bet it will pay a dividend. I am looking ahead 10 or 20 years with this portfolio and that’s why I own Yelp.

Why Is My Cost Basis In Baidu So Low?

Baidu-iconQuestion: How is it that my cost basis in Baidu is around $65 per share when I bought the position in May-July 2013 when Baidu was trading for $85-$95. Answer: the roll-over method.


I had sold $105 BIDU October 2013 puts for around $20 per share when Baidu was trading at around $85. Proceeds from the purchase were re-invested into additional BIDU stock. When the stock rose dramatically in the second half of 2013, those puts expired worthless. While I would have preferred a slower increase that would have allowed for a few “roll-overs” of those puts to pocket additional option time premium, I can’t complain. It was the portfolio’s best performing investment of 2013.


While I think the search engine business model is the best business model of all of the large internet companies, BIDU entails certain risks that Google does not. It doesn’t control the dominant smartphone platform and it doesn’t have as many ancillary services like YouTube, Google Docs, etc that keep people on their platform. It’s competitors are very strong, including Alibaba, Tencent and QIHU. And of course there is the risk that Google re-enters China some day. All in all, it’s a great company that has strong ties to the political class and I expect strong growth in the future. But it’s definitely not a sure thing.

Think About Adding Equity Lifestyle Properties To Your IRA

info_request_headerEquity Lifestyle Properties is a Chicago-based REIT that owns mobile home communities and RV parks. They are associated with Sam Zell, the famous Chicago real estate tycoon. They operate 376 properties containing over 138,000 sites in 32 states. Projected 2014 funds from operations (FFO) is $2.66, giving ELS a forward P/FFO of 13.6, which compares favorably with other high quality REITs like Realty Income (O). What I like most about ELS is that they focus on high quality properties and not just cap rates like some of the other mobile home REITs. Their properties are located near oceans and lakes and increasingly focussed on the sunbelt. That should lead to above-average rent growth and the possibility of future capital appreciation as the properties can be repositioned for higher-value uses. For example, their latest acquisition was a 25 acre park in the Florida Keys. Someday that might be a great resort; in the meantime I am fine earning the 7.3% FFO yield.

Like any REIT, I think this is a great holding for a ROTH or Traditional IRA. REIT dividends are basically taxed at ordinary income rates (with some exceptions) so having this in a tax deferred or exempt account makes a lot of sense.


The “Roll-Over” Options Method In (Painstaking) Detail

28002-rollover-accidents-2Can anyone think of a better term than the “roll-over” options method?


Here’s how it works: take a stock that you are very confident will be much higher in the future. By the future, I mean any time in the future – one year, 10 years, 20 years, whatever? The strategy is more profitable if the stock increases to your target earlier rather than later, but it’s not necessary. So let’s say you have a $50 stock that you think will eventually be traded at $90. What do you do?


If you have available funds, you buy the stock. But if you don’t have available funds you can sell long-term “put” option contracts at a $90 strike price. Those puts represent the buyer’s right to sell that stock to you for $90 and they generally sell for $90 – $50 (the current price) plus a small time premium (for an option this “in-the-money” the time premium is virtually zero) = $40. You pocket the $40 per share and buy the stock. Some day when the stock trades above $90 those puts will expire worthless and you’ll own the stock. You will have “created” that position without any cost basis.


Here’s a real life example. Walgreen’s sells at $57.50 right now and its $80 January 2016 puts trade for around $25.50 (roughly $80 – $57.50 plus a few dollars in option time premium). If you think WAG is going to be above $80 at some point (and not even necessarily by January 2016), you can sell 1 WAG $80 January 2016 put for $25.50 per share, which will net you $2,550. Then buy 44 WAG shares with the $2,550. You’ve added 44 WAG shares to your portfolio without any additional capital and without incurring margin fees.


What happens if WAG is not over $80 on January 15, 2016?  

Easy – you buy back the option and immediately sell another January 2017 $80 put option. You have “rolled over” the option, and now if WAG is over $80 on January 15, 2017, the put will expire worthless. Do this every year until the option expires worthless. If you picked the right stock to do this with, eventually you’ll get rid of the option. And I think WAG is a good stock.


But not only that, every time you do a “roll-over” you may collect a few dollars of option time premium. Imagine that you had $80 WAG January 24, 2014 options that you sold and now need to “roll-over”. No problem – buy those options for $22.5 in the next few weeks and sell $80 January 2016 puts for $25.50 and pocket the $3 of option time premium.


Then What?


Once WAG is above the put strike price of $80 at an options expiration, it expires worthless. But… if you think WAG is still a great stock that will increase further, sell another two year $80 put option and odds are that will also expire worthless. It’s tough to say how much that will go for but just for an idea the WAG $57.5 January 2016 puts currently trade for around $8.75.


Which Stocks To Do This With


My view is that the best stocks for this strategy are stocks with low dividend payout ratios, strong competitive positions and generally solid business models. Walgreen’s is a good example because historically they have paid out a low percentage of profits as dividends, which leaves a high percentage of profits to reinvest or buy back shares. Each will fuel share price increases. Other stocks with notably low payout ratios that come to mind are Direct TV and Google, which do not pay a dividend. Of course sometimes companies dramatically increase their dividend like 3M recently, but that’s generally a sign that the company is performing well. Google is a great example because it is building a large cash base and not leaking any of its earnings to shareholders as dividends. That may change, but I have a feeling that Google is more likely to institute a buy-back than a dividend.


The other factor to consider, which goes hand-in-hand with the competitive position and strong moat, is the ability to pass on price inflation. The simple ability to pass on price inflation can grow profits along with inflation, which all things being equal will inflate stock prices as well. Time, inflation, earnings, etc are all on your side with this strategy.




This is a risky strategy, obviously, because it hurts doubly hard when the stock falls. In a bad market even the best companies are likely to get hammered. If you do not have the time horizon to weather the storm, this is definitely not the right strategy for you.




The other thing to consider is your broker’s maintenance requirement. Writing naked options (ie options that are not hedged by a position in the underlying stock) incurs significant maintenance requirements. You can monitor this online with your broker. If your positions move against you, you may face a maintenance call and your broker will require you to liquidate positions (at precisely the wrong time). This is why the strategy should be used only for small positions (I suggest 5%-10% of portfolio value) so that you don’t risk a maintenance call.


In order to simulate what would happen if the positions were to decline, I suggest you run the numbers yourself using your brokers maintenance requirements. These can be found in your broker’s margin handbook and are quite complicated at first until you get the hang of them.


I think it’s a great strategy if used in small moderation and can promise around a 10% bump in your portfolio value.

Plans For the Portfolio

bigstock-Business-Concept----Object-49080398I wanted to give some context on where I see this portfolio going in 2014. Here’s what I expect:


The market will continue to be strong without any major event risk on the horizon (I don’t see any currently). Not as great as 2013, but good. Still, I think it’s going to be a stock picker’s market. No rising tide that lifts all ships. Stocks should start to diverge based on fundamentals, and I expect the weakest to actually go down this year.


That’s why I have some hedging built in to the portfolio. I am effectively short Herbalife, Angieslist and RadioShack through long-term shorts on in-the-money call options (I do that so that I do not have to pay dividends on the short positions and do not get the shares called by my broker – a post on that strategy later).


I expect Herbalife to continue to inch higher until one morning we wake up to the news that a state AG has started prosecuting the company. Bill Ackman has said that he is in discussions with regulators regarding on-going discussions and I don’t see how that can’t be true. Any day now…


I expect RadioShack to continue to show losses in 2014. There is little risk of a bankruptcy filing in 2014 given the new financing, so I’ll be holding this one for a while.


I am expecting Angieslist to drift lower throughout the year on disappointing results. Their subscription model is not the right long-term business model and the competition (HomeAdvisor, Yelp, Thumbtack and eBay) are continuing to improve. Those are solid competitors and free beats subscription if the products are of equal quality.


I am long Baidu, Equifax, Equity Lifestyle Properties, Experian and Yelp. I consider Equifax, Equity Lifestyle Properties and Experian to be the core of my future dividend producers and anticipate significant increases in their dividends this year. I have sold covered calls against Baidu at a $220 strike price to free up some capital from that position and may sell the position during the course of the year. I am anticipating continued strong growth from Yelp and a possible acquisition by another large tech company. I think the market will start to see Yelp as a “utility” type service for finding and transacting with local businesses (a point Jim Cramer has made several times) and $4.4 billion is far too low a valuation if that becomes a reality. The potential is too great.  Yelp has home run potential and is a bit outside my overall strategy but I see too much potential there. If it goes above $100 and my puts expire worthless I intend to sell new 2016 $100 puts for a large premium and purchase more Avery Dennison (AVY) or Agrium (AGU) or add a new position in Bemis (BMS), which is on the top of my list for new positions in 2014.

Why I Target Doubles and Triples and Ignore Home Runs and Singles

imagesMost of the financial independence crowd gravitates towards the familiar consumer giants like JNJ, KO and PG, as well as well-known large companies from other sectors, like XOM, CVX, GE, AFL, O, etc. The trouble with these giant companies that everyone already has in their portfolio is that they are too expensive to represent value and too large to generate growth. The vast majority of these will perform fine in a portfolio, but owning them is hitting a bunch of singles.


I prefer doubles and triples. That’s why I target mid-cap stocks. Over any 5 year plus period, the Russell 2000 index of small and mid-cap stocks almost always outperforms the S&P 500. Simply put, if you’re younger than 50, it makes more sense to own the Russell 2000 than KO. There’s more volatility and the initial dividend yield is lower, but if you’re younger than 50 that’s a good trade off for what is very probably higher return.


Here are the numbers. Coke (KO) is trading at an 18.5 forward P/E. Volumes are increasing at around 2% per year and prices are up around 2%, which probably lags overall inflation. The dividend payout ratio is 53%. Where is the dividend growth going to come from exactly? The payout ratio can’t go up much further (I’d estimate 60% is possible given the stable underlying business). The high payout ratio doesn’t give much room for a buyback to juice future dividend growth, and it’s hard to imagine the buyback making material progress beyond retiring new stock options unless the company incurs new debt. Simply put, without underlying profit growth, you’re looking at a 3% dividend that is going to grow slightly faster than inflation. And that assumes that Coke is able to leverage its distribution network to develop new products to offset likely weakness in its sodas. In the past, Coke has been a triple or even a home run if you go back far enough. But now it’s a solid single. Unless I have a few million or a nice pension (which I don’t), I can’t retire on Coke dividends.


Take Starbucks in contrast. If you had bought Starbucks several years ago it was an expensive growth stock that didn’t pay a dividend. But if you considered that its business model was solid and that its scale provided a wide moat that would allow it to continue to grow profits, you could have purchased SBUX and allowed it to mature into what is now a more mature business that pays a small 1.3% dividend yield. An investment two years ago into SBUX would have made you a 70% return compared to a less than 20% return in Coke (ignoring dividends). Starbucks hasn’t been a mid-cap stock but the point is that smaller companies with higher sustainable growth are going to have higher returns.

The best place to find sustainable growth is in my opinion in mid-cap stocks. Mid-caps have track records that you can rely on and (mostly) established competitive positions. Small caps might be a home run or a strike out but mid-caps are where you can do your dili and pick doubles and singles.


Maybe the takeaway here is that I might as well just buy the Russell 2000 and be done with it. That might turn out to be true but in the meantime I continue to think that I can add some value by at least weeding out the losers.