So, now you're rich, right?

 My latest post was delayed.  As I mentioned at the top, because I wanted to crow about how rich Tesla has made me.  Hmm.  Time to fess up.  It has been an utter nightmare, so far.  

It started nicely.  I bought a couple of call options in June of 2021, just before the stock went on a epic tear.  So, I bought more, and the more still, ultimately accumulating a net long position of 17 options.  That's a lot.  And, at one point, I was basking in a 10-Y paper gain (my Y had cost $60,000, so ten Teslas).  Then, the effects of coordinated short-selling and yet another Black Swan (this time the Russian invasion of Ukraine) combined to topple the price of a Tesla share to last Friday's 795.  Now I'm down three Y's, again on paper.  This occasioned a lot of portfolio shifting to maintain liquidity in the IB account.  No particular problem, as the rich returns in EPD left plenty of wiggle room.  

So today, I am staring at the exact kind of inflection point I've extolled in the past. Blood in the streets, panic everywhere, and yet a radiant future for the brave.  Why?  Because none of these external events have had any material effect on Tesla's prospects.  If anything, they are brighter than ever.  Why? This very month, Tesla will begin producing cars in two brand-new factories in Berlin and Austin.  The company is also doing a massive expansion in Shanghai.  While Elon is announcing a goal of 50% annualized growth to 2030, the actual results are FAR higher, more like 75%.  In the midst of raising prices steadily (the long-range Y I bought in 2020 is up about $10,000 in price), the company's wait lists have ballooned, in some cases to over a year.  Tesla just decided to prioritize deliveries to customers who purchase Full Self Driving (God I hate that misleading term!) for an additional $12,000.  That's pure profit, bringing the company's profit to over 50% of each vehicle sold!

The stark fact is that one company, and only one, makes a real profit selling electric vehicles: Tesla.  Everyone else stumbles along selling at a loss (every US and European maker) or at cost (the Chinese makers).  Only Tesla has achieved true economies of scale; the rest are just starting the excruciating climb.  

The lastest calamity (anyone else noticing that the pace of black swans is picking up?) has done almost nothing to damage Tesla's prospects.  The relatively small effects on its supply chain only improve its position relative to the pitty-patting herd.  Every instinct finely honed by decades of ups and downs (yes, feel free to chortle) tells me this is one of those rare moments of no-brainer opportunity.  Tesla around $800/share is a screaming bargain.  The fact that I was early (again, chortle permitted) makes it hard to double-down at these lows, but any kind of sustained recovery will free up liquidity.  

Looking at the elephant

I began this entry in September, 2021, and didn't publish it at the time.  Probably because I was waiting for the moment of triumph.  Still waiting.

For me it began with the decision to buy a car.  And, heavily influenced by a grim factoid (an average internal combustion engine spews about six tons of CO2 into the atmosphere every year), I landed on the obvious choice, a Tesla.  I'd like to think the choice of model was meticulous, but it actually came down to something my mom insisted on doing when examining new cars: sitting in the back seat.  The Model 3 was ... well, inadequate, the Model Y astonishingly generous.  The Y cost more, but since we were interested only in extended range versions, not particularly much more, say $5,000.  $60 grand later, and the car arrived IN OUR DRIVEWAY.

We were suddenly vaulted into the ranks of the cool.  My grandson started counting Teslas for sport, and was rapturous over the Karaoke function.  I performed endless range analyses, wondering just how far we could go without the dreaded recharge.  Turns out, quite a distance.  We can safely count on about 270 miles from full charge to cold sweat.  Neither of us likes distance driving anyway, so we've managed nicely on a mere two visits to a supercharger.  Otherwise, a "fill-up" takes about a minute a week, hooked up to our 220 volt outlet.  It happens overnight, and would cost just over $7.50 for a zero to full charge.  No oil change, no antifreeze, no transmission oil, as with ICE (internal combustion engines).   So, operating costs about 1/6 of what my daughter pays for her prized CRV.  

Now into the deep woods: thinking of Tesla as a possible investment.  I have to warn you.  There are fanatics out there, rabid on both sides.  They are as fierce as the demo tree-hugger/repubble-fascist warriors.  And, yes, I've ended up firmly on the Tesla side.  Don't particularly love Elon (it's OK, he probably thinks I'm old), but that's irrelevant.  I've talked before about black swans, as events.  Elon is a black swan all by himself. He is one of those rare individuals who have, through sheer persistence, clarity of thought and (let's not forget how important this is) wealth, prodded the entire world into a new gear it didn't even know existed.  Before Elon, EVs were eternally in the future, kind of like fusion.  Now, you'd need to be brain-dead to deny that they are here, are better, will soon be cheaper, and will, in a very short time, devour ICE like seal puppies blinking at a polar bear.  Except ICE companies aren't cute, so their passing will be far less cause for misty eyes.

Tesla is at the bleeding (intentional imagery) forefront of destructive change in its field.  What is striking is that most folks on the anti-side don't even understand what that field is.  They think it's cars.  It's like talking about an elephant by analyzing its tusks.  OF COURSE cars, but there's an entire convergence of technology and infrastructure Tesla is orchestrating that makes the ICE guys look like plumbers in tutus.  

Start with the car.  Teslas already match the safest cars on the road.  Soon, there will be no competition whatsoever.  Mind-bending performance.  Hit that accelerator, hard, and you'll never want to go back.  Really.  Don't believe me?  Just try one, once.  Efficiency?  Well, my Y's battery holds the energy equivalent of just over two gallons of gas.  Those two gallons would take my daughter sixty world-wilting miles; I could plausibly get 300 Bonneville-dam miles (out of the EPA rated 330-mile range).  So, five times more efficient, virtually no pollution.  Maintenance?  Well, basically none, at least for a LONG time.  Price?  Right now, at the upper end of mid-cost.  Like a tricked-out SUV, which the Y actually IS.   Tomorrow, cheaper, day after tomorrow, vastly cheaper.  

But that's just the start.  EVs are mobile batteries.  So, Tesla is designing and building the best batteries the world has ever seen, at steadily decreasing price-points.  So, while today's car batteries are relatively expensive, tomorrow's will become cheap, probably very cheap.  And the supply will grow geometrically.  Is that a problem?  Yes, but a good one.  Because there just happens to be a very good use for extra batteries, doing just what they do, storing energy.  

Which brings us to the next feature of the Tesla elephant: energy production and storage.  Tesla is designing and installing solar energy panels (a small, and relatively low-profit sideline), building and marketing home energy units (possibly a big deal), and building industrial scale energy storage solutions (potentially gigantic).  A startlingly little-broadcast fact is that solar power is already the most cost-effective solution for new energy generation.  A second startling fact is that wind power is the second most cost-effective solution.  Both have the drawback that they are intermittent, particularly solar.  So, peak generation often goes wasted, while low periods of generation might not meet peak demand.  Here's where battery storage kicks in.  A sufficiently robust battery adjunct perfects the already-cost effective solar-wind approach.  Interestingly, the more solar/wind you build, and the more the grids are interconnected, the less battery storage needed overall.  Massive "overbuilding" (aided by governmental energy policy) is the way to go.  Hyper-abundant energy would result, at unimaginably low price-points.  Tesla won't be the only player in this potentially colossal field, but it will be very big.  

More than any other vehicles on the planet, Teslas are mobile computers.  They receive and send data continuously, and most of the car's functions are controlled electronically.  Updates occur over the air, and improvements in driving technology are made available instantly to the consumer.  The game-changing aspect of this is FSD, full self-driving.  It was perhaps foolish of Tesla to use the terminology so early in the game, as it was, and continues to be, aspirational.  Nevertheless, the progress Tesla has made in the area is stupendous.  There is no longer any realistic doubt that the functionality will mature to the point that FSD driving is vastly safer (by factor of 10 to 100) than humans.  While there will unquestionably be deaths attributable to FSD, they will pale in comparison to the huge death rates we already experience.  No-fault insurance, probably much cheaper than today's, will compensate for those vastly reduced deaths. You can debate the timeline to FSD, but would be foolish to deny its inexorable progress.  As with most truly disruptive technologies, be prepared to be astonished by how soon it happens.  To quote Elon: "two weeks?".

Implications?  1.  Let the car drive while you do ... whatever.  Play games, watch YouTube, do some serious work.  That two-hour commute is now whatever you want it to be.  Work four hours once you arrive, then go home.  2.  Robotaxis.  Why own a second car?  Summon a ride at either end.  Cost?  Well, eventually far cheaper than owning that second or third car.  3.  Robotaxis.  Why own a car at all?  Once you think of travel as a service, available at all times, at a nominal price, then going commando will make sense.  3.  Robotaxis.  Go ahead and own a car, or two, or ten.  Just let a robo-fleet drive them all day long, paying you multiples of the ownership investment.  Get rich AND help the planet!

Wider implications?  1.  Death of taxi companies.  Duhh.  2.  Death of pay for parking.  Staggering implications for urban and suburban land use.  All those parking lots and structures, sitting empty, and available for new uses.  3.  Death of the gas station and ALL those convenience stores.  Sure, they'll put in chargers, but most of the charging will done at home, or in robo-taxi facilities.  The chargers that do flourish will be just like Tesla's supercharging network; fast (relatively, of course), ubiquitous, and convenient.  4.  Death of the big energy companies, particularly those producing and distributing oil/based products.  There will continue to be a large piece of business utilizing natural gas as a feed stock and a niche for meeting peak demand at various places and times.  5.  Death of conventional energy generation.  In order: coal (already moribund), diesel/oil plants next in line, gas-fired plants later on, but also in big trouble.  5.  Decentralization of the power grid.  Near-universal local generation from solar and wind, infinite sharing of power storage and delivery.  Energy flows both down (from the grid) and up (from homes, factories, farms).  

Believe it or not, there are many, and even wider implications.  This relates to the mathematics of disruption: the s-curve.  There is a wonderful chart (distributed by Tony Seba, see his video https://www.youtube.com/watch?v=Kj96nxtHdTU) showing how disruptive technologies follow a common pattern of very slow development, attainment of a break-through, followed by a near-vertical rise in adoption, then by stabilization at a level of near-universal adoption.  EVs are now clearly at the break-out point.  Adoption will NOT occur in a linear way (as most automotive analysts predict), but rather exponentially, growing ten or twenty times in a very brief period of time (less than ten years).  What Seba has pointed out is that we now have multiple disruptions occurring simultaneously.  Each one would normally proceed on its own s-curve.  However, the convergence of multiple technologies over the same time-frame will yield hyper-growth, and hyper-destruction.  

Advances in biochemistry and genomics, accompanied by breakthroughs in processing information, are already disrupting medicine and agriculture.  Vaccines can now be developed with unheard-of speed, and the curve will steepen.  Medicines of all kinds will now be cultured, or brewed with designer yeasts and microorganisms.  The field of brewing will revolutionize the production of foodstuffs, like proteins and starches.  The implications for agriculture are staggering.  Milk production will, fundamentally, collapse once its core ingredients (milk-fat, proteins, etc) are molecularly reproduced in the lab/factory.  Meat production will follow a similar trajectory.  Beyond Meat and Impossible are already producing products that compare reasonably well to ground beef.  There is no reason whatsoever, however, why actual animal proteins (and other unheard-of, unimagined proteins as well) cannot be produced in volume in vats, at a fraction of today's cost in land, water, pesticides, fertilizer and fuel.  Beef, dairy and grain-based farmers will be unable to compete; the value of their land will plummet.  Rural America will be rudely transformed to ... something very different.  

There is no point in debating this stuff.  It's going to happen, whether we like it or not.  Much of it will, unquestionably, be VERY good for the planet.  The death of fossil fuels by forces the energy companies cannot yet comprehend or combat, will, possibly, save us all from extinction.  And the rescue might occur far faster than even optimistic climate experts grasp.  How deliciously ironic that the very things we need most are the very things that are the most cost-effective by any reasonable measure!

 The bad is that literally billions of lives will be disrupted, some quite terribly.  If ever there were a time for intelligent governmental planning, this is it.  I think our build back better strategy should focus less on building solar and wind (that will happen anyway) and traditional infrastructure, and more on helping the people and society adjust to the fallout. Pumping money into the auto industry is simply folly.  Those jobs will disappear.  Better to help people retrain, possibly relocate to greener fields (literally).  A massive surge in construction just to support short-term employment offers poor returns on investment, unless the things produced or improved contribute directly to the economy.  Is that vague?  Damn straight it is!  Figuring it out won't be easy at all.  

Better to end on a bright note:  all this disruption will mean a vast decrease in the ultimate cost of living, world-wide.  Tony Seba estimates a basic maintenance cost of living per person might drop to $250/month, $3,000 per year.  The vast growth in world-wide GDP from the trends above would make supporting that yearly $3,000 trivial.

Post-Covid, Lessons Learned, Opportunities Realized

 I saw it in 2008, and again in 2020.  The worst of times can be the best, if you keep your head, and swing for the fences when the odds are stacked in your favor.  As nearly anyone could have predicted, there was no way that any administration, Democrat or Republican, would let certain vital American companies go out of business.  In 2008, it was the top ten banks, in 2020, it was Ford, and to a lesser degree, Macy's.  When the Fed hands a company money, either directly with a "loan" or indirectly, by buyings the company's bonds on the open market, you are looking at a functional guarantee.  Buy!  I did, both in 2008 and 2020, with huge results. My paper gain on Ford bonds bought in 2020 is nearly 40%, on top of the interest earned along the way.  While I think the future for Ford is dim, its centrality in the American economy means that the functional bond guarantee will persist for some time.

My second Covid course of action is a departure for me, from bonds to the world of MLPs, master limited partnerships.  Enterprise Products Partners (EPD) is a mid-stream player in the gas and oil realm, with a heavy emphasis on natural gas extraction, processing, and delivery.  OK, not great from a renewable point of view, but as an interim alternative to vastly dirtier energy sources (coal, fuel oil, diesel, etc), it has a bright future for a long time.  Its present yield is 7.6%, based on a distribution of $1.80 with a unit price of $23.50.  Since that $1.80 is treated as a return of capital, there are no taxes due on it until the stock is eventually sold.  I have a paper gain of 25% over six months, plus the distributions.  Since I use margin (a bit less than 1:1, the actual yield is about 13%, tax-deferred.  So, one-year paper profit about 38%.  The company is huge, and has grown its distribution for over twenty years.  So, not absolutely safe, but far safer than your average junk bond, with a better yield.

And now my epitaph to Transocean.  The company survives (is actually up quite a lot in 2021, its C rated bonds continue to pay interest), but I too now think I see the handwriting on the wall.  Deepwater oil drilling is nearly the last thing the world needs, and I don't see much hope for Transocean going forward.  I just sold my last bonds, at prices well above last year's lows, but well below purchase.  Here's the final snapshot:

                            Global Marine      Transocean Bonds    Options    

Trading gains:      $ 63,000                    -$31,500               $58,000

Interest                  205,000                     $80,000

So, nets gains over $360,000 on a stock that cratered, with no short-selling involved!  I'll take the results, but won't play this game again.

Covid, "Bodaciously'

Start out with a frank admission.  I have egg all over my face.  For all my talk of Black Swans, I managed to miss the boat pretty thoroughly when Covid began its inexorable march through the world's economies.  Most of my hi-junk purchases have suffered savagely: Bed Bath and Beyond, L Brands, Signet jewelers, and, of course, Transocean.  The only, barely, bright spot is that all four remain ... alive.  A couple of even worse choices, Ensco and Diamond Offshore have defaulted.

My extended dalliance with Transocean deserves a bit more discussion.  The Global Marine bonds of 2027 have drifted down to the 34 range, a huge drop from my average purchase price of 70.  Other Transocean bonds have had similar drops.  Yet, over the entire span of trading these bonds, my net capital loss to date is a relatively small $32,000.  Meanwhile, the bonds have returned $110,000 in interest.  My bout of trading Transocean options worked out quite a bit better: a net return of  $58,000.  So, while the stock dropped overall from roughly $20 to today's  $1.43 and the bonds have dropped to a CCC+ near-default rating, with a commensurate price drop to the mid-thirties, I have nevertheless made a very fair amount of money with Transocean.  Considering that I was drastically wrong about the company and its prospects over the five years I gnawed at the company's investments, a net $135K return is, well, very much OK.   Mind you, I had no business taking on such risks, but I'll take the final result.  Of course, I still own a few bonds, and might well see them drop to zero, but I'm inclined to think they will end up, at worst, as a wash from here.  If the company survives, they will sky-rocket, and even in bankruptcy, there might still be something here to mitigate the pain.  In fact, there is a bond maturing this fall, 2020, with an annual yield of 20%.  I've nibbled.

Despite all this awfulness, I still see some absolutely huge opportunities.  In fact, today's environment is very similar to the dark days of 2008-9.  Then, the elephant was the US government's embrace of America's largest banks, turning their 10% plus distressed bonds into investment gold.  Well, guess what: the Fed is now extending the same favor to a select group of distressed American corporations: most particularly to Ford and GM.  Ford was recently downgraded to upper junk.  In response, the Fed committed to buying its bonds, directly!  As in 2008, the message is crystal clear: if the US government has any say about it, these companies will not be permitted to fail.  So, that's a de facto AA rating.  Using the logic I last employed in 2008-9, I started buying Ford bonds sporting 12% yields; and nabbed a short-term Macy's issue yielding 24%.  As the bond prices started rising, I bought more, and then more. It's easier to handle psychologically when the thing you're buying is rising daily.   My paper gain, in less than two months of aggressive purchases, is $102,000. 

The rebound has been large, but yon can still get Ford at yields just over 8%.  Why should you be excited about 8%?  Well, remember the magic of margin.  At the exact moment that Ford and Macy's yields soared, the Fed cut its rates to near zero.  As a result, Interactive Brokers will now lend me money at an annual rate of 1.15%!  Assuming a fairly conservative borrowing ratio of 1:1 (half equity, half margin), $5,000 invested in an 8% Ford bond will yield $743, a return of 15%! 

Part-way into our Covid journey, I have suffered a net worth loss, on paper, of 10%, but have seen my annual income rise by 12%.  The risk side is a very heavy exposure to a single company (as was the case with Goldman Sachs in 2009), but mitigated by an effective government guarantee.

Is there a lesson to be learned?  Absolutely.  In "normal" times, reaching for yield is really quite dangerous.  Between 2016 and 2019, I bought a number of fallen angels (Bed Bath and Beyond, Signet Jewelers, L Brands), issues newly rated at junk, with yields hovering under 7%.  The Covid crash has made clear that 7% is not enough yield to justify that risk.  All three issues suffered further downgrades, and plummeted in price, eventually resulting in yields over 10%.  They may all recover, in time, but the recovery will probably only return them to where I started.  So, in "normal" times, it's probably a better idea to either park the money in cash, or accept the pedestrian yields available from investment grade debt.  It has become fairly clear to me that there will always be a new black swan, something unexpected that will arrive from nowhere, and terrify the timid.  Then the power of brave investing emerges.  So, it's better to be patient.

Update: August 6, 2020.  The magic moment was very brief; so I reverted to my own advice.  And lo and behold, the power of patience emerged in spades!  The steady recovery in bond prices has made my results drastically better.  My net worth paper loss from a February peak is now only 2.5%.  My income is now up 16.66% since February, while the paper profit on Covid purchases is over $220,000.  A note of caution: I am utterly flummoxed by the divergence between the stock/bond market (rosy prospects) and the clearly observable economy (an abysmal sink hole).  The obvious explanation is that the Fed is committed to propping the economy, no matter what.  Fortunately, this is a bipartisan stance.  While a number of Republican troglodytes are kicking and screaming, everybody else understands the need to keep the economy afloat.  The election of Joe Biden will, like that of Obama under similarly dreadful circumstances, work to keep the ship afloat.  So, as in 2008, the effective government guarantee of key industrial bonds will have been a windfall for investor who were brave when investing took courage.  Ahem, ahem.

The fruit is ripe. Now what?

This is one of those moments of inflection: the fruit is ripe, but the future is murky.

For several years, I have been on a lonely, silent crusade to identify value, and act upon the insights of my search.  The sore thumb of value investing has been energy: specifically oil, and its protracted, painful collapse.  From a peak of $107 per barrel in 2008, it plunged to a low of $37 in 2016.  Such a swoop is by no means unusual: prices hit $111 in 1980, and dropped to $32 in 1986.  A price of $43 in 1990 was followed by 1993's $28.  By now, a sane person must understand that volatility in oil prices is .. normal.  But that's not the way people look at things.  Each high has been accompanied by endless speculation that "this is just the start"; peak oil has arrived, and a world of endlessly expensive oil is just beginning.  The troughs also bring out gloom and doom, none more emphatic than the most recent set of predictions that peak oil's opposite (obsolete oil?) is on the horizon.  Shale oil drillers, along with electric automobiles, windmills, solar arrays and gigantic storage batteries, mean the end of fossil fuel, sooner rather than later.  So, oil will slump into irrelevance.  Stay away!

Except, it looks like the cycle is entering the next up stage.  2017's average domestic oil price has hovered around $43, up sharply from 2016.  And now there's a steady drumbeat of news regarding production cuts, and potential supply shortages.  The hurricanes have had an effect, but it's dwarfed by the stark fact that new production doesn't begin to compensate for drawdowns of existing supply.  So, very long term, oil might still dwindle into irrelevance, but in the next ten years, that's a TERRIBLE bet.  

Which brings me (surprise, surprise) back to my favorite value theme: Transocean as a proxy for oil.  Yes, I know it's only one small part of a gigantic tapestry, but it occupies an important niche; one that will unquestionably participate both in the downs AND ups of the industry.  I've followed the stock and (more importantly) bonds for several years now.  A careful, quarter-by-quarter analysis of its financial statements has led me, repeatedly, to predict the company's ultimate survival, and concomitant recovery of its stock (and more importantly) bonds.

We appear to be at an inflection point.  Most of Transocean's bonds have recovered from huge discounts to recent par and near-par results.  My favorite issue, the Global Marine 7% bonds of 2027 are how trading above 100 (par).  Considering that I bought significant numbers of these bonds at and below 40, the effect on my portfolio has been galvanic!

The story is still incomplete: bonds due in 2038 and 2040 still trade at a substantial discount to par (as low as 80), and sport yields above 9%.  And the stock still trades below 11, near the bottom of the range is has traversed since I got on board.  So, is Transocean still a value story?

I think so.  With bonds ten years out trading at par, it is clear that the cautious folks who invest in them are no longer worried about the company collapsing anytime soon.  Certainly, they think it will survive through 2027.  They still clearly worry about the longer future.  And the stock price still reflects deep worry about Transocean's immediate profitability.  But notice, profitability is NOT the same thing as survival.  The company will (bond-holders say) survive long enough to pay its debts through 2027; but it may not be a good investment (say the stock-holders).

Note: both groups might be right.  But it's really interesting that the historically most worry-prone group is now complacent.  To me, that is a good hint at where the stock is likely to go.  Would I bet the farm on it?  Of course not.  Rather, I will still (cautiously) push the bond envelope (maybe the 7.5% notes of 2031).  

And, continuing a theme I pursued awhile back, I'm also establishing paired options; long in-the-money calls with short at-the-money calls.  My present positions (a variety of leaps maturing in 2018 and 2019) will ripen to a gain of $20,000 if the stock closes at or above $10 in 2018 (the first set) or 2019 (the second set).  Since the stock is presently hovering above $10, this scenario looks pretty good.  I also have a few un-paired long calls ($5s of 2019), and am waiting for the stock to rise enough to permit the sale of corresponding 10's or 15's).  The magic point will probably be somewhere around $12.  Sounds like a plan.   Going forward, the story looks good. 

But not compelling.  Transocean can still yield generous returns, but no more home runs.   Frankly, I'm a bit at (Tran)sea.  The Transocean story was very clear to me a couple of years ago.  It looked volatile, and yes, risky.  However, the opportunity seemed to solidly outweigh the peril.  So, I took actions, step-by-step, and waited for the good news to trickle in.  It took a lot longer than I originally expected, but the narrative never changed.  

Now I need to find a new story. 

What will that be?  I have absolutely no idea, just a little faith that moments like this ultimately give way to clarity (and fear, and second-guessing).  

Update: April, 2018.  When you have a solid investment idea and commit to it aggressively, there is usually an extended period of uncertainty.  That's been the case with my recent flirtation with Transocean options.  The stock has been highly volatile, rising to over 11, and sinking back to the mid-nines.  I've used the drops to buy back short calls (which had dropped drastically as the stock receded) and establish new long positions.  I've also been shifting the portfolio from 2019 strikes to 2020.  At one point, very recently, the combined positions showed a paper loss of $14,000.  However, the recent burst to the mid-11 range turned that into a net gain of $18,000.  Now for reap mode!  The upturn enabled me to reestablish the spreads by selling at-the-money 2019 calls.  This locks in a 250% gain if the stock remains at or above $10.  So, to date, I have a total profit of $42,000 in realized and paper gains.  Since the cumulative investment is around $24,000, that's spectacular.  When a bet works out as predicted, the feeling is absolutely ecstatic!

The scenario above has played out at least twice since I began the Transocean option experiment.  Pairing options (long call in-the-money, short call at-the-money) allows for positive outcomes in both down and up markets.  The short calls gain value as the stock drops (that is, you owe less); the long calls gain as the stock rises.  So, you can buy back the short calls after a substantial drop, realizing a gain to cushion the long call drop.  Then, when/if the stock rebounds, short calls at-the-money can be written again.

Basic to this yo-yo investing is a correct judgement as to the long-term direction of the stock.  If Transocean were to begin the two-year cycle at 11 and end at 3, then the loss would be 100%.  NEVER forget that fact.  If it becomes clear that the initial thesis was wrong, then accepting a haircut (say 50%) would be wise, if painful.  This also means that you need to be quite greedy about the upside.  My rule of thumb is to try for a two-fer plus or better.  So, I want to turn a net $4000 investment into $10,000.  That's what my latest set of spreads will permit.  This lets me be wrong twice for every success, assuming I stop the bleeding at 50% for the duds.

The game works best (theoretically) with the longest LEAPS you can find.  The trouble is that the market spreads on the longest LEAPS are generally very high indeed.  So, it's usually best to wait a few months after they appear before buying the in-the-money initial positions.  Then you wait for your prescient judgment regarding the stock to be validated by the market.  After the rise, you can then pair the long calls with short ones at-the-money.  Good luck!

Update:  Just a couple days later.  Now the stock has jumped to $12.60, enabling me to sell another set of covering calls (2020 at 12),  Again, the potential profit for the 25 paired Leaps is 250%.  Selling the at-the-money calls also reduces risk sharply, as my uncovered positions are now down to 35 (from 60).  The swing over just a couple of weeks has been dramatic, over $40,000 to the upside.
And yes, I am very aware it can turn on a dime!  That's why I'm covering as the stock rises.

Update: October, 2019. 
Where to begin?  It's been absolutely horrid!  RIG was at $12.60 in my last update; now it's at $4.53! And that's not even the bottom, which was $4.24!  That's a stomach-churning 66% drop!  So, at least up to now, I've been consistently, terribly wrong about the stock.  AND, I've booked a net profit of $370,000 (income and capital gains) on the various bond and option investments!  The latter have been largely a wash, with 2019 drops pretty much wiping out earlier gains, but the bonds have performed marvelously.  I took advantage of a recent surge in price with the Global Marine bonds, which recent rose again to near-par, to lock in gains and reduce exposure to securities now rated in the CCC range.  This is not to say that I regard the bonds as lost money. In fact, I still own a fair number of Transocean and Global Marine bonds, presently showing a profit over purchase cost. But I'm watching them like a hawk!

Overall, it's been a humbling experience.  Throughout, my conviction level about RIG as a company was high, but faulty.  What does shine through, though, is the resilience of my thesis regarding bonds: they may wobble all over the place, but most of them muddle through.  For every Clear Channel, which ultimately died after a decade of torment, there are twenty stories of survival. And even lousy old Clear Channel, if traded judiciously, might have spun off handsome returns for the adventurous.  That's not my game, but there are times when I wonder whether it should be part of the grander scheme.

Black Swans and Crypto-Timing

My last blog was dedicated to my most recent extended topic: identifying value where others see trash, specifically relating to the driller Transocean.  Recent events seem to have validated my analysis, as the company's bonds trudge ever closer to par. This triumphant moment (actually, probably an extended period of small up-ticks) will present its own challenge: what to do next.  What new absurdity will the markets offer?

A great deal of scholarly effort has gone into examining the pricing of publicly traded assets, from tulips to cotton to gold to stocks to options and to bonds.  A very useful insight is that daily price movements are, by and large, random, while longer term movements are, by and large, dictated by large, fairly comprehensible trends (supply and demand, interest rates, the endless cycle of boom and bust, the equally endless swing from euphoria to fear, and the kitchen sink).  Of course, such trends are mostly clear only in retrospect.  Still, a considerable body of mathematical analysis has provided very useful tools for pricing things.  Perhaps most interesting is the attention now being given to "black swans", things that are (or supposed to be) very rare.  They tend to be ignored by standard pricing models, but their inconvenient (and statistically improbable) recurrence has made pricing things far less precise than the mathematically-minded like.  

Black swans have fat tails.  That means, if you look at a standard bell curve of things like IQ and height, you will see very small numbers at the far left and far right of the mountain.  In the world of finance though, the outliers are distinctly more numerous, so ... fat tails.  This means that really unlikely things are not, in fact, quite so unlikely after all.  

The oil collapse is a classic black swan.  No one predicted it, because it was, frankly, stupid.  If a large new supply of oil enters the market, then it makes sense for others to cut back.  That is, after all, the entire point of OPEC.  A little shared pain (by way of production cutbacks) would have made things far smoother for all producers, and the collapse would have been far less severe.  Of course, that's what is finally happening.  But only after a black swan spread its wings.

I personally feel this black swan effect is a boon to small investors like me.  Since they arrive unheralded, and with enormous disruptive effect, mainstream participants (brokers, analysts, bankers, company heads, etc.) tend to react en masse, and inevitably arrive at over-reaction.  With oil, predictions of calamity poured forth: $60/barrel, $40, $30, $20. 

Now black swan math is fiendishly complicated.  While it might lead to substantial improvements in the correct pricing of things (i.e. pay more for a option that is far out of the money than standard models would dictate), that is of little use to the small guy.  However, the large trend, that of extreme over-reaction, is very much open to him.  Will oil really hit $20, or $10, or $5?  If you really don't believe it, then a world of opportunity opens up.  Start looking at things whose pricing seems absurd, and ask whether the experts are missing the boat.  They frequently are. 

One thing that can be very useful to the moderately brave following a black swan is a persistent, stubborn form of market timing.  Analysts will often be in substantial agreement about a company's long-term prospects, but then recommend holding back: it's too soon, they will say.  Read market commentary about Transocean, and this theme recurs like clockwork.  Sure, the company will almost certainly double, triple, quadruple from today's depressed levels ... but it's too soon to commit.  

My question to them is: when is the right time?  When oil prices have already recovered, and the company has just signed a flock of lucrative new contracts, will that be the right time?  Question asked is question answered: NO! It'll be too late.  That double will have already occurred.

Just think a bit about the mathematics of doubling.  If you compound an investment at 7% for ten years, then it will double.  Most investors would be pleased as punch with that: a ten-year double.  So, believing, as most experts do, that Transocean will double, or triple, or quadruple in the next five to ten years, then WHAT ARE YOU WAITING FOR?  Pausing until "just before" the stock takes off is market timing.  What makes you think you'll be any better at it than all the other impulsive monkeys I've derided in past blogs?  If you act now, and it turns out you're five years early for the double, then you compound at 15%!  If you wait until the stock has nearly doubled already, well then you will probably miss the boat entirely.

While this line of thought applies equally to stock and bonds, the latter offer a special reason to act sooner rather than later: you're being paid to wait for the upturn.  Some of my Transocean bonds were purchased at current yields of 20% and more.  Default would have made that choice feel rotten, but the subsequent price recovery has turbocharged my portfolio.  Did I lose a little sleep along the way?  Sure did.  


June 2017.   The stock has dropped, sharply, to $8.50.  This is due to renewed worries about the price of oil (now about $45/barrel).  There's an uptick in commentary about the death of oil; renewables will make the internal combustion engine obsolete ... etc, etc.  The only thing, though, is that the world continues to consume nearly 100 million barrels of oil daily, while replacement exploration lags by a huge margin.  Take a very recent year: 2015.  Net discoveries were 2.7 billion barrels; less than 1/10 the usage for that year. 2016 was worse: 2.4 billion barrels. This imbalance dwarfs ANY potential upsurge in supply from any source, much-trumpeted shale included.  In a fairly short time, there will almost certainly be a huge gap between supply and demand, even if demand falters considerably.  I can't predict the inflection point, but today's extreme pessimism will, I believe, look really foolish in just a couple of years.

Interestingly, Transocean's bonds have held up quite well during the recent kerfluffle; the Global Marine bonds of 2027 have dipped back into the high 80's (from the low 90's), and seem fairly stable there.  Their 9% present yield is certainly junk-level, but half of what it was only a year or so ago.  

The company's recent financial actions are revealing.  First, they sold a number of rigs to Borr Drilling, receiving a cash infusion of $320 million and sharply reducing future capex outlays.  In May, they then did a private placement :  roughly $400 million, maturing in 2022 with a very favorable rate of 5.5%.  

So what will the company do with the cash infusion?  Just this week, we got an answer.  It issued a tender offer to retire $1.5 billion of its debt from 2017 to 2021.  This is NOT the action of a company with liquidity problems.  The company will end up saving a good deal of money in interest payments over the next few years (clearly the point), but there's no way it would be tossing over $1.5 billion in cash if management had any concerns about paying the bills between now and 2021. This is yet another step in the smoothing out of its debt/capex curve, in anticipation of better days following 2021. 

Bottom line; these recent actions are favorable for all Transocean debt. Pushing the liquidity horizon out several years vastly improves the chances of making good on all their obligations. What it means for the stock is murkier (the price dropped a fast 7% when the news hit), but that's probably knee-jerk.  

When I first started writing about Transocean, the stock was chasing $16.  The longer term bonds were trading about 80 (a bit lower than now).  I boldly predicted that the crisis in oil would be over in three to six months!  Well, THAT was wrong! Instead, there has been a thrilling series of rapid rises, followed by sickening plunges.  The stock rose briefly to $20, and I predicted a return to "normal" of 30.  Well, THAT was wrong!

The stock plunged, and so did the bonds.  But then it rose to $21.  The rise let me close out some options at a very nice gain ($7500).  Good thing, because the subsequent drop in stock and bond prices was sickening.  I kept buying bonds, and they kept dropping.  I froze in place for a good while, but when the Global Marine bonds hit 40, I actually forced myself out of paralysis and bought more.  Very good thing indeed, because the next move was up.  These bonds moved steadily into the low 90's, bringing my overall Transocean results sharply into the black.  

So, I began with the stock at $16, and it's now $8.5.  But I've actually MADE a lot of money along the way (some of it paper profits, but I could realize them if I wanted).  All this while being pretty much wrong about what was "going" to happen.  The reason is that I was not wrong about the company itself.  By concentrating mostly on the bond story, and the company's agile steps to protect its fiscal strength, I have done very well indeed.  

With the stock so low, I'm now, very cautiously, purchasing a few more long calls (3's and 5's of 2019), with the intention of selling corresponding strikes (10 or higher) once (if) the stock recovers.  The amounts are low; the possible profit margins huge.  Yes, a 100% loss is entirely possible, but so is a triple or quadruple.  

What is Still Cheap

My earlier blog with this title has grown like Topsy.  It's very long.  Throughout, my answer to the question of cheap was ... Transocean!  Its stock, its bonds, everything.  Now I know that opinions differ.  For two years now, a solid majority of stock (and bond) analysts have clawed away at the company.  A solid majority recommend sale of the stock, and consider the bonds to be dead money.  Moody's bond downgrade to Caa1 is the exclamation point.  Yet, quarter after quarter, Transocean rolls along, beating consensus earnings projections, retiring debt, husbanding money and managing future cash flows with finesse.

[3/13/17.  Why Transocean in particular?  Aren't there dozens (hundreds) of other companies equally mis-priced, with equal, or superior, prospects for recovery?  YES.  Yes indeed.  So why haven't I dug in, investigated, analyzed, probed deeply, and come up with a comprehensive list?  The answer is not complicated.  I'm just one guy with just so much time to spend on this obsession.  It would be safer to have a long list, but the task grows geometrically as you expand that list.  I don't need thirty outliers, as long as I'm right about THIS one.]

In the last year, the company has retired about $1.2 billion in near-term debt and issued $2.4 billion in longer-term debt (maturities in 2023 and 2024).  While the terms of one issue were onerous (9%), the most subsequent issues, backed by recently delivered drilling rigs, are a more modest 7.75% and 6.5%.  Note the positive trend in financing costs.

Moody's will undoubtedly squeal even louder than before, pointing out that all the new issues are senior to older, longer-term debt.  That's true.  That seniority thing, though, is a liquidation issue.  IF the company defaults, then the newest debt will be paid first, to the disadvantage of the older debt.  To me, the vital point is that the new money pretty much insures that Transocean won't default at all.  It solves the company's cash flow issues well past the critical year of 2020.  That year's $2.5 billion of capex and debt maturity threatened the company's fragile cash hoard.  The additional cash cushion provided by new debt floats the company over the next five years of financial rocks.

Once I became convinced that Transocean's near-term challenges had been addressed, I bought quite a lot of debt maturing in 2018 and 2020.  All of it has floated to and above par.  Even more interesting is the recent action in later maturities, like my go-to Global Marine bonds (7% of 2027).  After bottoming to a sick-making 42, they are now flirting with 80!  Now that's still a depressed price, with a present yield of 8.75% and a potential total return of 42%, assuming a two-year return to par.  So, the bargain is intact.  It's just not as spectacular as before.  Add a bit of margin, though, and the two-year return could easily rise to 80%.

The company is still at the mercy of oil's murky cycle.  With it now floating near $50 a barrel, there will be little money to be made for awhile.  But still, some.  Transocean has a fairly robust backlog (about $12 billion), so will undoubtedly pull in between $2 and $3 billion in gross revenues for awhile.  Lean and mean, with a good cash cushion, it will be ready for the upturn.  As a bond investor, I really don't care if Transocean thrives in the long run.  Mere survival is very much OK with me.  In the meantime, I'm being paid, very handsomely, to wait.

February, 2017.  I probably should wait until Transocean posts its 2016 full-year results before commenting further.  But, I'd like to be a bit out front, and take a pot shot or two at the ratings agencies.  Recent price action in Transocean bonds has been very strong.  Since my last update, the Global Marine bonds have topped 90.  That's a very large move, and directly contrary to the drastic ratings downgrades issued both by Moodys (Caa1) and S&P (B-).  I've stated before that Moody's is in the midst of a hissy-fit.  S&P's B- for Global Marine, contrasting with its B+ for all the other Transocean issues, is also just weird.

These guys seems to miss every boat.  Back when the bond was trading near 40, their ratings were far higher.  Then, just as the bond began a huge recovery, they decided to issue punitive downgrades.  The very actions Transocean took to shore up its balance sheet were treated as disasters by Moodys and S&P.  Investors, though, seem a bit shrewder.  Global Marine price improvements have matched the supposedly "stronger" Transocean action point for point.  Buyers of all issues seem to understand that improving the balance sheet for the company as a whole makes each and every individual bond stronger, not weaker.  As to the supposed difference between Global Marine (a wholly owned Transocean entity) and Transocean itself ... well, there really is no meaningful difference.  S&P is splitting hairs, assuming they even understand that Global Marine is just another Transocean obligation.

February 26, 2017.  Year-end results for 2016 are in, and confirm exactly what I've been predicting.  Most striking is that the company's cash position is now about $3.1, up over $700 million from a year ago.  Mark Mey, at the company's earnings call for 2016 summed it up:

"We are certainly washing cash right now. We have over $3 billion of cash. I’d like to take you back 12 months so the last year this time when oil was trading at $26 a barrel, capital markets were firmly struck for off-shore drillers, that’s what the change. So, we have a full capital market option available to us whether it's secured, unsecure or any other type of instrument that we’re going to put in the balance sheet. So, I don’t feel that we’re under pressure at the moment to enhance liquidity. We will take opportunities as they provide themselves to us."

For a bond investor, this near-incoherent utterance is nevertheless music to the ears.  Even though the company is still experiencing falling revenue, the capital markets are no longer concerned about the company's ability to pay its debts.  So, they are increasingly willing to lend Transocean money.  The company's ability to obtain increasingly favorable credit terms during 2016 bodes very well for 2017 and beyond.  

The first order of business will (I suspect) be to renew and extend its $3 billion line of credit.  Much like a HELOC (home owner's line of credit), the money can be drawn, paid back, and drawn again at the company's discretion.  The flexibility this provides cannot be overstated.  

The effect on Transocean's debt pricing is steadily clearer: everything is rising, even the most far-dated issues.  I expect that nearly one will hit (and exceed) par in 2017.  At that time, the game will be over for me (and you) as buyers of Transocean debt, but most certainly not as holders.  Just as my Goldman Sachs purchases of 2008 and 2009 are still nestled in my portfolio, spitting out predictable bi-yearly payments, so will the Global Marine bonds and their longer-dated sisters.  

March 9, 2017.  And Now the Missing 10K!  After the very soothing conference call announcing excellent financial resuls for 2016, Transocean then muddied the waters by delaying the release of its 10K form, the "official" statement of earnings.  The company cited unspecific issues with controls relating to tax accounting.  This delay was received badly; the stock and bonds all dipped, wiping out the nice bumps following the news conference.  Uncertainty scares people, particularly bond investors.  Many sell first, then decide what it all means.

Now, ten days later, the 10K is on file. The delay certainly didn't mean they had to start from scratch. So, what's going on, and how serious is it?  There are sections in the 2016 10K that shed a little light.  It's about income tax accounting:

"Specifically, the execution of the controls over the application of the accounting literature to the measurement of deferred taxes did not operate effectively in relation to: (1) the remeasurement of certain nonmonetary assets in Norway, (2) the analysis of our U.S. defined benefit pension plans liability and associated other comprehensive income and (3) the realizability of our deferred tax assets and the need for a valuation allowance."

Transocean pays very little in income taxes right now, $107 million, down from the 2015 $200 million figure.  I think that's important.  A sharp movement up or down would still be small, relative to the company's cash flow and balance sheet.  And that's ultimately, exactly what the 10K eventually says.

Attached are two letters from Transocean's auditors, Ernst and Young.  They are both dated March 6, 2017.  

The first is harsh: "In our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, Transocean Ltd. and subsidiaries has not maintained effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria."

The second, though, is a plain-vanilla endorsement of the company's publicly released results for 2014, 2015 AND 2016:

"In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Transocean Ltd. and subsidiaries at December 31, 2016 and 2015, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein."

Bottom line: the company is getting a sharp rebuke for sloppy accounting practices, the impact of which are "immaterial".   I suspect Mark Mey's head is on the chopping block for professional sloppiness (just look at the vapid way he talks), but Transocean's recent stellar results are the real deal.  

I suspect the two letters explain the 10K delay: Ernst & Young needed to complain about financial controls, Transocean needed the auditors to validate the bottom line.  It took ten days to iron it all out.

Is the recent price weakness a buying opportunity?  Probably, but I'm kind of stuffed right now.