Update to my Portfolio

It was a very interesting week. I have made few buys and some sells, here are the highlights:

What I bought on Wednesday during the market decline:

• I added more of Brookfield Properties (BPO) at $17.50. I think BPO has unique assets in high barriers to entry markets. I ignored the noise of higher vacancy rates due to the turmoil on the financial markets and expected layoffs from banks. The company has good management and I think buying it at this time for the long term is worth of the risks.
• I added to the FirstService position. FirstService is commercial real estate service company that is trading now at less than the valuation one division of their holdings, which is residential property management. The company is mistook as a brokerage business and it is being punished because commercial real estate transaction are almost vanished. Sure its brokerage business will suffer but the residential business is solid. The company is being opportunistic and buying other businesses at the moment to position its business for the rebound. Its management is good and they are aligned with shareholders as they have an economic interest of about 25% of the company.
• I have added to Haliburton option position. I am under water on the position but I think HAL has room to run here and very attractive on a valuation basis.
  

What I sold in today's rally

• I sold US Bank corp into today's rally. I bought USB at $30 few months ago and it reached my valuation target I sold at $38, a return of 26% plus dividends received through the holding period. USB is very fine bank it avoided all the nonsense that is plaguing most banks today. It actually closed at 52 week high today. I think the bank is very solid with good management and focused on its core business with no ambition for empire building. But I got to get out right now on valuation basis.
• I sold United Rentals @ $17.45. I have lost on this position as I bought it at $21. I have entered into this trade to take advantage of a tender offer the company initiated but it did not work as I intended.
  
• Sold small position from my fixed income as yields have came down significantly during the panic. Prices of government bonds have went through the roof lately I am selling into that panic.

I still have a lot of cash I need to deploy but I am not in hurry. I have my shopping list and I will wait for attractive valuation, as I think we will visit some of the lows we have witnessed in the past.

United Rentals: update

The tender offer has been oversubscribed and as a result the company prorated the buyout to all tendered shares, so each investor who tendered their shares sold a prorated 37.5% of tendered quantity. They have purchase 37.5% of my shares at the minimum auction price of $22.

Lesson for tender offers: always trade in odd lot quantities, i.e, less than 99 shares. This way your are guaranteed to get bought out by the company. You can buy different odd lot quantities in different accounts in your kids, spouse..etc name and tender it that way. In the future I will always by an odd lot quantity to participate in this type of trade. I have not bet any significant amount on the position and I will never do for these type of special situations and I do not advise of risking more than 1% of the portfolio on such trade as the upside is limited while the downside can be significant.

Currently I am waiting for an opportune time to sell the remaining shares and close my position in United rentals. It will be at loss of about 14% if I sell now.

Close of my Hedge

I have two updates concerning two of my positions. My put on the S&P I have decided to close my put option on SPY @ $4.35 per contract, my original cost was $3.6, a 20% gain in less than two months. The SPY was 139 when I purchased the option and 130 when I sold it, 6.5% decline. I think there is still room on the down side for the overall market but these calls are not my game and I try not to action them. I have several reasons to close the position, however none of these reasons invalidate my original rationale for buying the put, see my post here, actually my original thesis is more valid now that it has been couple of months ago. My reasons to close the position are:

1. Time value of the option is deteriorating now as the option is getting closer to expiry date, so I am not able to get adequate "pop" in the option for each point decline in the S&P.
2. The prevailing expectation is for a decline in stock over the immediate term, and when every one is thinking the same way it is hard to make money. I have taken the put when Wall Street was talking about recovery and the market have gone up unjustifiably. Puts were cheap based on their volatilities, no body wanted them so I bought, now they are a bit more rich.
3. Shorting using options is about timing and timing does not fit in my circle of competence; general market analysis is outside my scope of strong abilities.
4. Options are very tricky; your prediction can be right on the money but you still would lose money using options, there are may moving parts in your valuation.
5. I need the cash to be ready to buy for my long-term positions.

Recap opportunity- a clarification: A reader has called me on this, so I need to clarify something that may have escaped my writeup and that is the issue of risk in modified auction position of United Rentals (URI). I have said concerning the position "....little or no risk..." I used that term very loosely. There is a risk in this opportunity definitely, there is always risks in any position you take. The biggest risk with this position is not be able to get bought out by URI. URI is buying one third of their outstanding stock so if more than one third tender their shares and your price is higher than the auction price you will be still holding your shares after the auction. I just thought to clarify the issue of risk in the position.

Recap Opprtunity

United rentals (URI) began a modified Dutch Auction today. A dutch auction is an auction in which an item is initially offered at a high price that is progressively lowered until a bid is made and the item sold. In this case URI indicated that they will buy back 27,160,000 shares out of their 86,000,000 outstanding shares at a price not less than $22 and not more than $25. Shareholders will tender their prices at a price they choose or they can elect to just tender and accept whatever price is finalized through the auction process. URI will look at all the tendered share prices and start to work their way up from the lowest tender price until they satisfy the required quantity of share buyback and the sum of that amount divided by the quantity of the shares to buyback will determine the auction buyback price.

I have not done any fundamental analysis on the company to determine its value because the way I looked at it is as follows: I do have an opportunity to make a quick profit with relatively little or no risk as I bought in below the the auction price range. However as I looked at the details of the auction and the financials of the company there is a good potential for a nice price appreciation after the buy back is completed. Moreover, insiders are buying heavily into the company, actually a big chunk of this company is owned by insiders. As I go through the owners list I see that Bruce Berkowitz have bought in at $18 a share. Mr Berkowitz is the founder and the Managing Member of the Fairholme Fund who boosts a stellar track record of value investing. That peaked my interest in the business.

URI has an Entp. Value(EV)/ EBITDA multiple of 5.5 on a TTM basis. After the recapitalization, if the market to apply the same multiple to URI's business, its shares should appreciate to high 30s. URI could use its $500 million cash to do the recap or borrow more either way their Enp. Value will not change, but shareholders will get a bigger piece of the company cash flows. If I reverse solve for URI price and market cap after the recap I should get $38 per share as per table below. Now the market may not keep the same multiple due to more debt added to the balance sheet but the potential for a run up in the price of URI have a high probability of occurring.

	TTM	Recap
Shares	86.406	59.246
EV	$3,946	3,946
EBITDA	$718	718
EV/EBITDA	5.5	5.5
Mkt Cap	$1,902	2,404
Price	$22	38

As for the business itself United Rentals is

... an equipment rental company. During the year ended December 31, 2007, excluding its traffic control operations, the Company’s network consisted of 697 rental locations in the United States, Canada and Mexico. It offers for rent over 2,900 classes of rental equipment, including heavy machines and hand tools, to customers that include construction and industrial companies, manufacturers, utilities, municipalities, homeowners and others. In February 2007, the Company completed the sale of its traffic control business to HTS Acquisition, Inc., an entity formed by affiliates of private equity investors, Wynn church Capital Partners and Oak Hill Special Opportunities Fund, L.P. In February 2007, the Company acquired High Reach Equipment Services, LLC (High Reach).

The company's customer base is commercial contractors that account for 70% of their business. The commercial construction is not dead and continue to do ok but may suffer in the near future, who knows. I am not a top down guy so I do not put a lot of emphasis on economy and sector outlook when analyzing a company.

The problem with an operation like URI is it will hardly generate any free cash flow, although they will have fantastic profitability margins. The business requires a steady and continuous capital investment to maintain operations. If you look at URI free cash flows for the past 10 years, it is highly variable. The company ends up blowing all of its cash flow from operations back to the business to buy more rental equipment. The company during the past 10 years have generated negative cumulative free cash flow in the tune of $1.4 billion.

	1998	1999	2000	2001	2002	2003	2004	2005	2006	2007	TTM
Cash from Operations	216.1	421.4	512.7	696.7	517.9	342.3	737.0	643.0	858.0	868.0	961.0
Cap Ex	(564.2)	(841.8)	(962.0)	(497.3)	(709.4)	(377.9)	(649.0)	(823.0)	(965.0)	(990.0)	(845.0)
Free Cash Flow	(348.0)	(420.4)	(449.3)	199.4	(191.5)	(35.6)	88.0	(180.0)	(107.0)	(122.0)	116.0

Some may argue to exclude capex in this situation as the company is still growing and need to add to its equipment fleet. Ok lets assume that the company will grow at the same rate forever, then what? They will never generate any free cash flow as they will need to add more to their assets to match fuel revenue growth.

The company, no doubt, has improved some of its metrics and profitability in recent years and its recent recapitalization may add more value to its shares. However, I am not in a hurry to hold it long term as I am not confident enough in my analysis, or more accurately the lack of, so i will tender my shares at $23.5. A price in the middle of the road and will yield me a nice return for couple weeks of holding, if it was tendered.