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.  

Why am I so darn smart?

All right, all right.  I'm not that darn smart at all. But I still can lay claim to investing results that match, or exceed, those of some awfully smart people (yup, Warren, Bill, Will, etc).  How can that be?

If there's one truism for the past fifty years, it's that it is VERY hard to beat the averages in the stock market.  Active investors, whether individuals or fund managers, consistently fall short of the indexes they attempt to best.  Frankly, the contest is so uneven that most rational investors have long since given up.  They have fled to index funds, or ETFs in droves.  That's a good thing.  Very few active fund managers beat the averages over time.  Most underperform drastically.  Are the ones who succeed really that good?  Well, a dart board will probably answer that question.  If enough people toss darts, a few will hit the center.  Are they geniuses, or just lucky?

Still, I have had great results, for quite a long time, with my bond investing.  I've only tracked my results in detail since 2008, but over the years, I've had additional home runs (RJR Nabisco, AT&T and AT&T Wireless bonds).  One issue, one only, defaulted: a stupid, fortunately tiny, purchase of  CCC rated  Southeast  Bank in 1991.  I have, upon occasion, sold a position for a loss (Clear Channel springs to mind), once my comfort level was breached.  However, through thick and thin, the overwhelming majority of my bond positions have flourished.  Time and again, an issue bought at a substantial discount has recovered to (and frequently above) par.  (Update Feb 2017: And this is not just due to past good luck.  My bond-investing results for the year just completed are very solid: 15%.  This in a time of historically low bond yields!  What about 2017?  Well, too soon to say, but the year has started out well,  and that 15% doesn't look unobtainable at all.)

One possibility is that I'm a bond-picking genius.  Pause for applause.  But far more likely is the fact that most bonds find a way to avoid default.  They may experience violent up- and downdrafts, but ultimately, the great majority limp through.  Bond owners, on the other hand, are a frantically skittish bunch.  The slightest whiff of trouble sends them heading to the exits.  In their rush to sell, bond prices are disproportionately depressed.  Suddenly, an investment-grade company will trade, temporarily, with yields far above its cohorts.  Here is a partial list of such companies (all of them presently in my portfolio):  21st Century Fox, Abbey PLC, AXA, Bed Bath and Beyond, First Union,  GTE, Goldman Sachs, Hartford, HP, Lombardy, Morgan Stanley, Protective Life, Southern Copper, Telecom Italia, Telefonica Europe, Time Warner, Transatlantic, Union Carbide, Validus, Vale, Viacom and Xerox.  Folks, that's a long list.  Most of the companies are at the lower end of investment grade, but every single one has recovered from its swoon, and made every interest payment along the way.

So, in a nutshell: the stock market is so frantically efficient that it's really really hard to beat the averages.  And the bond market is so wildly inefficient that a doofus like me can tiptoe through it and harvest the low-hanging fruit.

How is this possible?  Well, the very things that make me unable to compete on the stock battlefield seem to favor me in bond-land.  I'm tiny, I can only buy small driblets of things, and my activity has no effect whatsoever on the prices of what I buy and sell.  That idiot who dumped his Time Warner bonds because a merger fell through passed them to me.  A bond manager won't waste his time on a five or ten-bond position.  I'm happy to.  I keep nibbling until the opportunity passes.  What's astonishing is that the opportunities keep cropping up.  Right now it's energy.  To be sure, the most outrageous bargains have disappeared (25% yields for distressed Transocean), but 12% is still available.

Now, why will YOU be unable to make this work for YOU?  Because, my dear reader, you are probably human.  Your fear will make you wait until the best opportunity has passed, your greed will make you grab for things that are overpriced.  Really.  How do I know?  Because my own fear and greed have snared me time and again.  It takes real stones to buy when others are bailing.  It takes Spartan discipline to hold back when the market has just hit an all-time high.  I think I'm best at the low points.  A solid record of success in troubled times makes me willing to dip my toes in.  I'm no longer taking huge chances: just bite-size ones.  But enough morsels make a very good meal, eventually.

I've been writing this blog for over six years now.  To date, a grand total of perhaps ten people have looked briefly, and walked away (metaphorically) forever.  Yet I persevere.  Why?  Well, the pain is quite low, and I remain optimistic that, at some point, more than one person will take it seriously.  Then there might be a geometric increase in interest.  Why this optimism?  Because I am convinced that I'm on to something, something valid, actionable, and potentially life-changing.  I has been so for me, and could be for many other folks as well.  How many?  An excellent question I just asked myself.  Clearly not millions.  A flood of folks pursuing the same approach would quickly overwhelm the limited array of opportunities.  It would be just like the demise of the January effect.   But dozens, hundreds, thousands?  Yes indeed.  My approach to bond investing has been hiding in plain sight for generations.  I doubt intensely that I'm unique in seeing it all.  Scattered around the country are undoubtedly dozens, perhaps thousands of fellow travelers.  Perhaps they're looking at my blog in secret, cursing me in secret for giving it all away.  Perhaps.

Leaps and Leverage: A Lab Experiment

Yeah, once again the old guy skates out onto thin ice!  After telling the world that the only good game in town is bonds, here I am talking about the near polar opposite, a security DERIVED from a stock.  And I don't like stocks in the first place.  So, why even go there?

Well, I'm retired, and have a good deal of time on my hands.  And my bond game is slow.  Now that's actually a good thing.  The whole idea behind them is to take a carefully risk-adjusted position and wait for time to make it all good. It's an excellent game, and has worked through a variety of market conditions.  Even in today's ultra-low yield environment, I have consistently found situations where the risk-reward ratios seem very favorable.

Well, options present a whole new world of scenarios, where risk-reward is magnified.  The risk is ever-present, but the rewards are occasionally so tempting that I get ... tempted.  Here's the kind of thing I'm talking about.  A volatile stock (like Transocean, RIG) has an entire world of even more volatile derivatives: calls and puts.  I'm not going to give a basic lesson in these right here.  Suffice it to say that a call is the right to buy 100 shares of a given stock for a given price and period of time; a put is the right to sell 100 shares for a given price and period of time.  As a stock fluctuates, these things swoop!  Call prices rise faster (percentage-wise) than the stock does, and fall faster.  Same thing in reverse for puts.

I'll only be writing about calls here.  Buying one has limited risk, but that risk can involve the entire amount you've invested.  Say you buy a call maturing in January of 2018 (this is a LEAP, or long-term option), strike price of 13.  Today, with the stock trading around $12.50, that call would cost somewhere around $3.  Since the call cannot be exercised profitably at present (the strike price is higher than today's stock price), the call is "out of the money" and the $3 is entirely time value, or opportunity cost.  If the stock rises to $16 by 2018, you could exercise it, but make nothing at all.  At $19, though, you double your money by selling for a $6 return, netting $3 on an investment of $3).  That's a 100% profit.  Every $3 additional adds 100% to the profit.

Is buying this option a good idea?  Well, I'd call it pretty bad.  The stock has to rise 23% before you can break even.  You need to be very confident to justify the risk of losing your entire investment.

Selling a call is intrinsically even riskier.  You pocket a premium (in this case, perhaps $2.50, since the bid is always lower than the asking price), but accept unlimited risk.  If the stock shoots from today's $12.50 to $30 (hey, it traded over $50 a couple of years ago, with a historical high of $171!), you'd lose $18.50 for each $2.50 you took in.  Is that a good idea?

You get a completely different concoction when you blend the two, though.  Establishing a spread, where you buy one kind of call and sell another, can be vastly less dangerous, but still profitable.  For example, you could buy a 2018 call with a strike price of 8 and sell a 2018 call with a strike price of 13 for a net cash outlay of $3.  The long call costs more than the short call, but the money coming in from the short call reduces the total cost.  They key to a spread is that the long call lets you supply the shares being demanded by the owner of the call you sold.  In this example, you could receive up to the difference between the strike prices, or $5 per option pair.  Such a spread has a potential maximum profit of $2 (the difference between the two strikes ($5) and the cost to establish the position ($3)).

Is this a good idea?  Well, the potential profit is 66%, for a spread that expires in 1.5 years, or 44% annualized.  Sounds pretty good, right?  BUT, you can still lose it all.  How?  If the stock closes below 13 in January of 2018, you start making less and less.  At $12, you now make $1 on the $3 invested (sell at $12, buy at $8). Still OK.  At $11, it's break-even.  That's not OK, since you've tied your money up for no gain at all.  At $10 it's a 33% loss (-$1 on $3 invested), at $9 it's a 66% loss and at 8 or below, you've lost it all, 100%.

To me, this is still unattractive: a maximum potential gain of 66% versus a potential loss of 100%.   To be sure, I think the odds are in favor of the gain, rather than the loss.  But who knows?

There is a wrinkle here, though.  IF the stock's upside potential looks favorable versus its downside ("if" is a very big word here), then it can pay to establish the long call (lower strike price) first.  It too has a potential loss of 100%, but if your hope of upward movement is realized, then all calls will rise in tandem with the stock.  For a call out of the money, the rise won't be 1 to 1.  For the $13 Transocean call, for example, the stock would probably have to rise nearly $2 for the option to go up $1.  But assuming that movement does occur, then the option can be sold for a higher price than today, thus lowering the cost of the newly established spread to $2, down from the $3 it would cost now.

What does this relatively small change mean for the investment?  Well, now the potential profit is $3 on a reduced investment of $2.  That's 150% upside.  That's enormous.  Since you're considering this step because you are optimistic about Transocean's price prospects moving forward, suddenly this risk-reward scenario looks pretty good.

Bottom line: I decided to run a sort of lab experiment, based upon the fundamental analysis above.  I've been doing this approach (buying long calls, then writing short calls AFTER the stock has risen) for a few weeks. Transocean stock as risen sharply (from $9.50 to $12.50) during this time, a busy engine providing forward momentum.  So far I have written 15 spreads, all with this potential for a 150% gain versus possible 100% loss.  I still have 20 long calls (bought more recently) with no corresponding short position.  Transocean will need to rise about one more point for the next leg to work similarly.

How will this all turn out?  I'll keep you posted (and no, I won't delete the post if it all turns to mud).

December 1, 2016.  The worm turns!  OPEC just announced an agreement to stabilize/reduce output.  The entire industry boomed.  Transocean stock jumped from under 11 to nearly 14.  Prior to the jump, I had bought a total of 35 calls January 2018 with a strike of 5 (average cost $5.83), 10 calls with a strike of 3 (cost of 8.5) and sold 15 calls January 2018 with a strike of 10 ($3.8).  So, that original spread was set to yield nearly $3 on a $2 investment, or 150%.  My kind of deal.  Subsequently, the stock dropped severely, bringing my net option position to flat, and even (briefly) negative territory.  As stated repeatedly, this is no game for those with palpitations.

With Tuesday's news, though, the situation reversed drastically.  Now the overall position shows a paper gain of $10,000 on a cash investment to date of $17,000.  The rise in the value of the 10 calls (to $4.25) enabled me to sell another 15 calls.  Since they can be matched with the long 5 calls purchased at $5.83, the net cost for the 15 spreads is $1.58.  Assuming Transocean closes at or above 10 in January 2018, the profit will be 215%.  I still have 15 unspread long calls.  If the stock keeps rising ...

December 5, 2016.  Another rise in the stock has enabled me to cover my final 15 long calls with a paired short call.  The final sales were priced at $5.10.  Now, I can just wait.  If Transocean closes at or above $10 a share in January 2018, then I will achieve a maximum return of $24,500 on a net initial investment of 9,323, or 250%.  Not bad on a total move upward of roughly 30% in the underlying stock.  At this point, the maximum profit looks highly probable, as Transocean is priced nearly 40% above the $10 strike price on the short calls.  The position already shows a paper profit of $11,100.  I'd be tempted to grab that, rather than wait for the additional $4000 to materialize in a year or so.  The problem is that unwinding the position, paying asking prices for the short calls and receiving bid prices for the long calls, would eat up most of the difference.  Unwinding in January 2018 will be automatic, and cost-free.  So, I'll be patient.

It all sounds so simple; just a hugely leveraged version on the buy low-sell high scenario.  Note, though, that I spent several weeks looking at a sizeable paper loss  At one point, it was down about 33%.  If I had thrown $100,000 or $1,000,000 at the bet, my sleep cycle would have suffered.  As it is, the sharp drop seemed small enough to ignore.  My reading of the basics (oil supply/production cycle, company internals (revenue vs debt vs capex) made the trade look very promising; so I didn't sweat the highly visible risk.

From here on out, I'll concentrate on the bonds.  That's my long-term strength, and I still see signficant opportunities for the company's longer-maturing debt.

January 8, 2017.  It should be clear from my blog over the years that I believe getting rich slowly is a better long-term strategy than its opposite.  However, if you are determined to play the stock game, looking for companies that are undervalued, and relying upon the market to recognize and eventually reward your insight, then this particular options spread game seems very promising to me.  Working with leaps give you up to two years of breathing space.  The risks are very clear (shame on me if I haven't put them front and center), but the rewards can be breath-taking.

My own results are far too spotty to suggest a comprehensive investment strategy (like the Bodacious Bond Portfolio).  And a year like 2008 could (and, for me, did) ruin your day, week, and year.  Still, a disciplined, laddered series of spreads, diversified over industries, might be very powerful.  A few winners could overwhelm quite a few losers.

The big question here is whether is it even possible to outguess the market.  By that I mean, a stock (or bond), at any given point, represents the best combined judgement of hundreds, perhaps thousands of pretty shrewd people about a company and its prospects.   It's fairly arrogant to disagree.  Yet, hind-sight lets us see how often, and dramatically, this shrewd consensus misses the mark.  Prices leap up beyond reason, and plunge equally beyond reason.   The consensus-makers are constantly looking sideways at each other, and betting on what those peers are going to do.  Kind of a circle-jerk, if you want to be crude (I do).  Pros generally prefer to stumble with the herd than stumble conspicuously alone.  The fact that they get graded, four times a year, and in full public view, makes them skittish and a bit stupid.

This gives an individual investor a huge advantage.  Nobody cares what you, a boob in the sticks, is doing.  So, they won't make fun of you, because you're invisible!  That's a very good thing; you can, in theory, be brave without fear of public humiliation.

I'd love to talk to others about this approach, and I might even try to continue my lab experiment past 2018.  I suspect that it will, in time, turn into another get rich slow scheme, due to layers of diversification.

Annuities Revisited, With a Vengeance!

My wife recently retired, and we faced, once again, a deluge of tempting things to do with her 401K and other retirement funds.   Coincidentally, a friend asked me about a juicy annuity:  he could cash in a company 401K plan worth $200,000 and get something like $1000 monthly, "forever!"  "That's 6%!", he exclaimed.  In fact, the world is beating a path to senior doors, all making similar pitches. For example, Barron's Magazine just listed the 100 "BEST" annuities in America.  Leading the list of plain vanilla annuities are offerings from American National (5.8%, $966 monthly) and Guardian (5.79%, $964 monthly).  There are endless variations, with survivor benefits, inflation adjustment, foot massage, etc.  The moral?  Be afraid, very afraid.

My first question to anyone interested in an annuity is whether he gets the difference between "return on principal" and "return of principal."  At this, most people's eyes glaze over.  They should reach for the Visine instead.  In my friend's example, the 6% is a return ON principal, but there would never be a return OF principal.  As Mark Twain learned to his great regret, the difference is crucial.  The company is going to keep the original $200,000, no matter how long you live.  If you live a VERY long time, the payments might make up for loss of principal, but like your virginity, the pristine annuity investment is gone forever.

There is a very simple way to test whether an annuity is a good idea.  Pretend you're a bank yourself, "Sybaritic Seniors?".  Assume some home-buyers come to you, hoping to borrow that self-same $200,000.  Like any standard borrower, they expect to pay a fixed amount per month. After the final payment, in say 20 years (the average life expectancy of a 65 year old buying an annuity), they want to own the home free and clear, owing Sybaritic Seniors nothing at all.  They ask you to set the monthly payment at $965.  Doesn't this sound a whole lot like an annuity company seeking to borrow your $200,000 with a $965 monthly return?

Pull up any basic mortgage calculator.  You will find that a $200,000 loan with a monthly payment of $965 over twenty years implies an interest rate of 1.5%!  Would you, in your wildest dreams, ever lend that kind of money for that length of time for that tiny return?  Wouldn't that just be ... stupid?  All an annuity company (your bank's customer) would need to do to get rich is find an investment that would yield over 1.5% yearly, and pocket the difference.  Gosh, where would they ever find that?  Well, there are THOUSANDS of investment-rated bonds that yield over twice that 1.5%!  Some would yield three times as much.

There's more bad news here.  If your 401K or IRA was funded with pre-tax dollars (most are), then the annuity payout is taxable!  At 25% (pretty common for average folks), your post-tax return plunges to $724, or 1.125%.  Ouch.  But wait, as in an infomercial, THERE'S MORE! Over the last 16 years, the average rate of inflation in the US has been 2.24%.  That means, as in the above example, you are losing over two dollars to inflation for every post-tax dollar you receive. This is how an annuity can put you on a Friskies diet in a few years. Yum!

If I were in the annuity business, I would just find a few (thousand) anxious seniors, wave that tempting "6%" in their faces, actually pay off at the rate of 1.5%, and slurp the cream for the next couple of decades.  With any luck, those lenders will do you the extra favor of dying early.  In that case, you still have their money, but no longer owe a dime!

Now, let's pause a moment.  The annuity is not, of course, actually a mortgage.  The example above assumes a fixed-rate, fixed term mortgage (1.5%, 20 years).  In real life, an annuitant might live much much longer.  If she lives to 100, then total payments of $521,100 might look pretty good.  But, remember that $200,000 of it was her money to start with. Even under this extreme scenario, the compounded rate of return over that 35 years is still a mere 2.77%!  And don't forget the terrible news about income taxes and inflation.

Now do you understand why everybody and his brother is trying, frantically, to sell you an annuity?  Taking the above example, it would make sense for the seller to hire a bunch of aggressive salesmen (call them financial advisors, if you like), and pay them 5 or 10 percent off the top.  He's locked the suckers in for decades, so what's a little baksheesh among friends?  He'll still get rich on the carry, they on the bribe.

In one of my very first posts (October 2010), I suggested the common-sense alternative to an annuity: a few carefully chosen BBB-rated bonds, coming due about the time you think you will ... come due (or later, of course).  You can still find some of these yielding north of 6%, particularly energy issues.  Yeah, they're considered risky and volatile, but in the bond world, that still means the great majority will pay off, in time and on time.  Diversification would handle most of the risk.  $200,000 invested in such bonds would return $1000 a month for twenty (or thirty, or forty) years.  Then, when the bonds mature, you will still have the $200,000 you started with.  Great for you, or your grateful heirs.  And if you really need extra money in the meantime, you can always sell off some of the bonds.  They trade on the open market, after all.  Try asking your annuity provider for the same consideration!