Thursday, November 15, 2012

Do Not Panic About Seth Klarman's Sales

Seth Klarman’s actions should be taken into consideration because of his admirable record, a return of 20% per year since 1983. In the beginning of this month, I wrote about BP (NYSE:BP), the biggest position of Seth Klarman. In the second quarter, his Baupost Group owned nearly 13.5 million BP shares, accounting for 14.2% of his total portfolio. His second biggest position was Hewlett-Packard (NYSE: HPQ), with more than 26.8 million shares, accounting for 14% of his portfolio. However, in this third quarter filing, he has trimmed down these two positions significantly. The position in BP was reduced by 16% to 11.26 million shares, whereas the position in HP was reduced by 46% to nearly 14.38 million shares. His total equity portfolio decreased from $3.8 billion in Q2 to $3.3 billion this quarter. What are the key takeaways for investors after Seth Klarman’s recent actions in equity market?
Overall, the potential fiscal cliff fear has driven investors out of equities, triggering a huge sell-off in the broad indexes. I think Seth Klarman has been raising more cash to bet on new investment opportunities arising from the recent market downturn. BP is still his biggest position with more than $477 million in value. BP is one of the major global oil/gas players with 17.75 billion BOE of proved reserves, higher than that of Chevron and Royal Dutch Shell. The company’s recent error was the Gulf of Mexico oil spill crisis (Deepwater Horizon). The company estimated that it would take $40 billion to clean up everything. In March, it reached $7.8 billion settlement for the crisis’ economic losses. To date, it has paid out $19.1 billion into a trust fund for this oil spill incident. Even including this, its balance sheet still looks strong. As of September, it had $118.8 billion in stockholders’ equity; debt was less than half at $49 billion. BP still had more than $16 billion cash on hand. In addition, it raised its quarterly dividend by 12.5% to $0.09 per share, which would be paid in the next quarter. At the current price of $40.54 per share, the total market capitalization is $128.75 billion. The market is valuing the company at only 7.3x P/E. 
Klarman’s second largest holding, Hewlett-Packard, is still a struggling business. The poor performance is due to weaker PC environment as tablets and mobile devices have replaced PC gradually. Ben Reitzes, a Barclay’s Capital analyst just cut his 2012 sales forecast from 363.92 million to 352.75 million PC units. He projected a 4% decline to 338.34 million units in 2013. He commented about Hewlett-Packard: “we are cautious on HP’s PC segment given secular pressures, share losses, market confusion over ultrabooks and Windows 8, and a slowdown in markets like China”. Famous short-seller Jim Chanos thought that HP was a value trap, as it kept growing via acquisitions. So the free cash flow after adjusting acquisition costs was a huge negative number. He was pessimistic about PC business: “Laptops will continue to lose market share to tablets and other devices. People will still buy PCs, they just won't make as much money." HP’s CEO Meg Whitman believed that the turnaround plan for the business would take time. As 2013 would be a fix-and-rebuild year, investors should not see any sign of recovery until 2014. Over the past twelve months, HP has generated losses. It is trading at $13.14 per share; the total market capitalization is $25.84 billion. The market is valuing HPQ at 0.8x P/B. 
My Foolish Take
There might be some other reasons for the reduction in two biggest positions in his portfolio. There is no reason to be panic if we are confident in our own judgments. Personally, I think HP would be an opportunistic play on the turnaround plan. Investors might buy into HP if they believe in Meg Whitman to lead the business successfully. It is really a bet in Meg Whitman. For BP, it can be considered a value play, as the business has a strong balance sheet, trades at low earnings multiple and pays a good dividend yield for investors.

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