Special Situations, Bye Bye Alibaba, and More

Provided to subscribers March 30th.

Here is the latest from Canadian Value Investors!

• Special Situations – 111, Inc. (YI) and Activision Blizzard (ATVI) chug along; new Chembio Diagnostics, Inc. (Nasdaq: CEMI)

• Coal Update

• Bye Bye Alibaba

• The Demise of Credit Suisse

• Silicon Valley Bank (Canada) Wind Up

But first, our poetry reading (CVI copywrite pending)

Alibaba, Alibaba, you've served us well

But as a Canadian investor, it's time to sell

The risks and regulations, are just too high

It's time to say "bye bye" and wave our goodbyes

Investors, investors, it's time to say goodbye

To the Alibaba shares, we once held so high

It's time to move on, it's time to break free

We'll never say "bye bye" to investing, just this company

We'll take our profits, and invest them anew

Our portfolios will thrive, and continue to accrue

So here's to you, Alibaba, we raise a glass

To a future of success, as we let go of the past

Special Situations - Yi and Activision Blizzard chugs along, new Chembio Diagnostics, Inc. (Nasdaq: CEMI)

Coal Update

For those keeping track, the Australian election adds more noise (see previous posts for companies covered). Canada and Australia are just like Brazil and Mexico, just more expensive. Shenanigans is underpriced in the former, and overpriced in the latter.

https://www.bnnbloomberg.ca/australian-energy-minister-rules-out-ban-on-new-coal-mines-1.1888246

Australian Energy Minister Rules Out Ban On New Coal Mines

(Bloomberg) -- Australia’s energy minister has ruled out a ban on new coal mines as part of the country’s overhaul of climate policy.

“That’s not part of our agenda,” Chris Bowen said when asked directly about the prospects for a ban on the ABC’s Insiders TV program on Sunday. “It won’t be part of those negotiations.”

The government was elected on a pledge to end the country’s climate wars and last year passed landmark legislation mandating emissions cuts of 43% off 2005 levels by 2030. However, the bill left the detail on how the cuts will actually be achieved to future debate.

Bye Bye Alibaba (NYSE:BABA)

Disclosure: We are long Alibaba but are exiting shortly.

We hoped you enjoyed our poetry reading. Alibaba has announced its division into six separate businesses: domestic e-commerce, international e-commerce, cloud computing, local services, logistics, and media and entertainment. The domestic e-commerce group will include Taobao and generates the majority of the company's revenue. The latest gossip can be found here - https://www.bloomberg.com/news/live-blog/2023-03-29/alibaba-briefs-on-breakup-plan

This is to “unleash productivity”, but really – we think - it is to address the Chinese government’s concerns of having giant powerful corporations that can push against the Chinese government around. The Chinese government is worried about avoiding the American outcome of having megacap corps, due to their potential economic dominance and political influence, never mind their access to sensitive information. We would be worried too. Over the long-term, we think their approach might work out better for their situation and society. This is also a practical approach for the company. They are significantly undervalued compared to their Western peers and, frankly, in absolute terms, and a spinoff is the textbook way to fix this.

More importantly, we are exiting because there is a real risk that Canadians lose access to the Chinese market, or face some sort of serious friction or expropriation by either the Canadian or Chinese government (we hope that Canada and China can be friends one day). Alibaba having a New York Stock Exchange ticker was a symbol for the Chinese government to protect from a reputational standpoint; six smaller names are not.

Our bet was on the combined entity. There are easier problems to solve in the world, than to figure out how to value these entities and which ones we should stay in or swap into/out of given the political risk. However, if we were Chinese nationals we would work on this problem.

We are thinking about potentially selling a series of long calls (high volatility, high premiums) or buying puts (significant jump in the stock; potentially a lot further to run before the split but protect downside). But there will be no long position.

The Demise of Credit Suisse

Great article on the collapse of CR.

https://www.netinterest.co/p/the-demise-of-credit-suisse

“So why the urgency to shut Credit Suisse down over the weekend? “Credit Suisse meets the capital and liquidity requirements imposed on systemically important banks,” declared its regulator just four days earlier. (“We welcome this statement of support,” tweeted back Credit Suisse, rather sweetly.)

In its dying throes, the group had a regulatory capital ratio of 14.1%, ahead of its 13% target, and a liquidity coverage ratio of 144%. Once central bank support was factored in, that liquidity coverage ratio jumped to 190%, signalling that the bank had sufficient liquidity to meet almost 60 days of stressed deposit outflows.”

Silicon Valley Bank (Canada) Wind Up

Silicon Valley Bank had a Canadian Branch, similar to other foreign banks operating in Canada. PWC was appointed as the liquidator and the full filings can be found here - https://www.pwc.com/ca/en/services/insolvency-assignments/siliconvalleybankcanada.html The endorsement provides a good summary - https://www.pwc.com/ca/en/car/silicon-valley-bank/assets/svb-004_170323.pdf

[2] SVB is a U.S. bank based in California. It offers commercial and private banking products primarily to clients in the technology and life science/healthcare industries and global private equity and venture capitalists. SVB is jointly regulated by the U.S. Federal Reserve Board and the Department of Finance Protection and Innovation (“DFPI”).

[3] In Canada, SVB is an authorized foreign bank pursuant to the Bank Act. In 2019, the Minister of Finanace authorized SVB to establish a branch in Canada (the “Canadian branch”) and the Superintendent authorized it to carry on business in Canada. SVB is regulated by the Superintendent with respect to its Canadian operations. The Canadian branch has been primarily focused on lending to early and mid-stage start-up businesses in Canada in the technology and life sciences sectors, as well as to venture capital and global private equity firms that assist Canadian start-up businesses in those industries. The Canadian branch is not authorized to accept deposits from Canadian sources.

[4] On March 8, 2023, SVB announced significant losses. The following day, investors and depositors reacted by initiating withdrawals which caused SVB to be incapable of paying its obligations as they became due. It is insolvent. On March 10, 2023, the DFPI appointed the Federal Deposit Insurance Corporation (the “FDIC”) as receiver of SVB. On March 13, 2023, FDIC announced that it had transferred all SVB deposits and substantially all of SVB’s assets to a newly created FDIC operated bridge bank (“Bridge Bank”) to protect the depositors of SVB.

[5] In Canada, on March 10, 2023, the Office of the Superintendent of Financial Institutions (“OSFI”) advised SVB and the Canadian branch that it was taking control measures to ensure that sufficient assets were maintained in Canada. On March 11, 2023, the Superintendent appointed PwC as its representative to assist in the supervision of the Canadian branch.

CVI Portfolio Update – March 2023, Three Special Situations

Here’s the latest from Canadian Value Investors!

• Portfolio Update

• PBR Petrobras – Quick Note

• Three Special Situations – YI, MTCR, MAXR

• Charlie Munger at the 2023 Daily Journal AGM Notes

Favorite chart of the week – Fastest IPO bankruptcies of the SPAC boom. Some of these are just egregious. For example, Electric Last Mile IPO’d at a market cap of $1.4 billion through a reverse SPAC. https://www.cnbc.com/2021/06/28/electric-last-mile-is-the-latest-speculative-ev-company-to-go-public.html If you are curious what investors were told, here is the S-1 filing for the IPO. https://www.dropbox.com/s/f6w9oyfyjovc58s/20230304%20Electric%20Last%20Mile%20Solutions%20Inc._S-1A_2021-03-31_English.pdf

Portfolio Update

Petrobras NYSE:PBR.A – Quick Note

See our February 13th post in the website archive for full background of this position.

Since our purchase and post, Petrobras announced their quarterly dividend of R$2.7457336, or roughly 10% for the quarter, albeit a bit of a complex mechanism. We plan to spend our dividend cheque on a Pabst Blue Ribbon family pack. 2022 production was higher than target (2.674MM boe/d vs target of 2.6MM), refinery usage hit five-year highs, methane emissions intensity continues to decline, and they are running the largest offshore carbon capture program in the world. They are also trading at a 2-3x forward P/E. However, we expect this holding will be a rocky ride. https://www.reuters.com/business/energy/lula-bashes-petrobras-dividends-says-firm-invested-almost-nothing-2023-03-02/

Financial reporting, transcript, and presentation are here - https://www.investidorpetrobras.com.br/en/results-and-announcements/results-center/

For example, the government just announced a temporary suspension on asset sales, which does not have any material impact but provides an indication of their mindset. More importantly, the Lula administration also announced a temporary 9.2% export tax on crude for four months, which will eat up about $400MM of that expected cash flow (earnings of ~US$34 billion in 2022 and market cap of US$69B). The political risk is real, but the bet is coming off the table fast.

We are watching the new CEO (government appointed as usual) closely. Here are some Q4 conference call highlights of new CEO Jean Paul Terra Prates responding to tough questions:

Responding to Luiz Carvalho at UBS “how to avoid conflict of interest between the controller, shareholder minorities, politicians and the company best interest in the decision-making process?”

Luiz, first of all, try to change the orientation. You are the sell guy, change that. Well, I think the challenge here, and this question is very good, because it's very common, Luis. Because of the recent past and the not so recent past as well, it is fair to have this kind of impression or conclusion that Petrobras will be subject to politicians, et cetera, et cetera. Not that it was not subject to this in the recent years as well. We had and we have to remember that. We have very recently, 2019-2020, politicians and government making Petrobras to surrender market share in fuels and leaving refineries at half of the capacity. So this is not something that doesn't happen here and there.

Now, the big challenge that we have altogether is to turn the participation of government in Petrobras into our favor, not against us, make our investors have the certainty that to be a partner of the Brazilian state is not a disadvantage on the contrary. It's good.

It gives us good leads to things. It gives us good dialogues and less risk when we go to a new area, to a new horizon when we discuss legislation, regulation when we are present in the regions, when we have to deliver new projects with the communities, with the mayors with the city councils, et cetera, et cetera. This has to be an advantage.

Since it's a reality, and it's not going to change. If somebody doesn't want to be a partner of the state of Brazil, it has other options. People have other options. Then you will be right to say sell. But right now, this is a reality for us, and it never changed. It didn't change on the Lula and the Dilma, on the Bolsonaro, on the Tamar and it will not change with Lula now for sure. So Petrobras will still have the Brazilian state as a majority partner.

That being said, we have to deal with that reality, the best way we can. So this is part of our business.

…

So upstream oil and gas will keep being our main focus, this represents already 83% of our investment portfolio. So it may stay about that. I could try to guess, and this is my responsibility individually that we would not, in the short term, not even in the midterm, go over 20% to 25% of that amount in investments into other things, including refineries transformed into biorefineries or natural gas into new segments, but also on offshore wind or bio whatever components in fuels, et cetera, et cetera, renewables in general. This will not be a transition that will make very fast, but certainly has to be a transition that we effectively have to be done -- doing. We cannot stop one day to think about the energy transition. That doesn't mean that we are going to do the transition, all of a sudden. There's a big difference between these two things.

…

Petrobras is Petrobras, it's a huge vehicle of investment and investors should look at Petrobras as a secure investment. It may be not the high heat of every day in the markets, but it must be the most secure destiny of the money of our investors. The one that people can trust. The one can -- people can give -- probably can give shares to their sons and run funds.

Maybe we will one day give our shares to our children. In the meantime, announcements like this were expected by us and aren’t helping.

Petrobras on letter from the Ministry of Mines and Energy

—

Rio de Janeiro, March 1, 2023 – Petróleo Brasileiro S.A. – Petrobras informs that it received Official Letter 166/2023/GM-MME from the Ministry of Mines and Energy (MME) yesterday requesting the suspension of the sales of assets for 90 (ninety) days, due to the reassessment of the National Energy Policy currently underway and the establishment of a new composition of the National Energy Policy Council (CNPE), respecting the Company's governance rules, commitments made to government entities and without putting Petrobras' interests at risk. The Board of Directors will analyze the ongoing processes, from the standpoint of civil law and within the rules of governance, as well as any commitments already made, their punitive clauses and their consequences, so that the governance bodies assess potential legal and economic risks arising, subject to the rules of secrecy and other applicable governing rules. Relevant facts will continue to be disclosed to the market. Facts deemed relevant will continue to be disclosed to the market.

Special Situations - YI, MTCR, MAXR

Charlie Munger at the Daily Journal AGM

Another great event with Charlie Munger. Highlights below. https://www.youtube.com/live/9VVPO3KWj3A

"California is trying force it's wealthy people and wealthy corporations out of the state, and I must say it's working fine, they're leaving one after another."

On crypto - "Sometimes I call it crypto crappo, sometimes I call it crypto shit. It's just ridiculous that anybody would buy this stuff."

He used leverage for Alibaba and other ideas recently. -

This question comes from Michael Gallagher he says according to company filings it appeared that Alibaba shares were purchased with leverage and when the stock price fell last year he was seemingly forced to sell he being you can you ask Charlie to confirm that it was bought with leverage and if so why would he do that, as it seems to go against his philosophy?

Well yes it's true I operated with no leverage for long stretches of my old age and Warren's the same way. Recently I did use a little bit of leverage here and in another place because the opportunities were so ridiculously good I thought it was desirable to do that. You're right, it's unusual for us. By the way, if you go back early in my career I used some leverage. I sometimes ask myself a mental question; “what is the appropriate percentage of your net worth that you should put in a stock if you think it is an absolute cinch?” If you are the kind of fellow who is right when you think something is a cinch, the answer is 100%, maybe 150%, but nobody teaches people to think that way in finance. But if the opportunity is great enough, the logical answer is 100%. Or maybe 200%.

Q: You have said the three things that ruin people are ladies, liquor, and leverage, so why would you use leverage if that is one of the three things that can destroy somebody? Well, I used a little leverage on my way up and so did Warren by the way. The Buffett Partnership used leverage regularly every year of its life. What Warren would do is he would buy a bunch of stocks, and then he’d borrow against those stocks and used it for event arbitrage liquidations. That was like an independent banking business and Ben Graham name for that was Jewish treasury bills; it always amused me that that is what he would call them. Warren used leverage to buy Jewish treasury bills on the way up and it worked fine for him. Berkshire has stock is Activision Blizzard – whether it will go through or not I don’t know – but that is a Jewish treasury bill. We sort of stopped doing it because its such a crowded place. But here is little Berkshire doing it again and Munger using a little leverage at the Daily Journal Corporation… “The young man knows the rules and the old man knows the exceptions.”

On Alibaba - "I regard Alibaba as one of the biggest mistakes I ever made ... ln thinking about Alibaba, I got charmed by their position in the Chinese internet and didn't stop to realize, 'they're still a God-damned retailer."

"If you're just not crazy, you have an advantage over 95% of the population…If I had to name one factor that dominates human bad decisions, it would be what, I call denial. If the truth is unpleasant enough, their mind plays tricks on them, and they think it is really happening. Of course, that causes enormous destruction of business.”

Is he worried about the future of Berkshire? “I don't worry about it too much because I'm  going to be dead."

“Dumb is forever”.

December Portfolio Snapshot, YI Exited

Here is the latest from Canadian Value investors!

• 111, Inc. Christmas Gift

• Portfolio Snapshot

• Other Things from Around the Web

111, Inc. Update (YI) – A Wonderfully Bizarre Christmas Gift (~35% return, silly 1000%+ IRR)

Disclosure: We no longer own this.

Back on November 1st we wrote about 111, Inc. Key insiders are looking to take the company private and relist in China. This is part of the ongoing wave of Chinese companies delisting from U.S. indexes and we have participated in and written about a few of these.

The stock was trading at ~$2.75 and insiders wanted to take it private for US$3.66 per ADR. Things were chugging along, with the Board’s special committee working away on their “independent” opinion with their advisors. However, the stock jumped above the offer to $3.70-$3.90 range on Tuesday. Why?