Blogs y foros de trabajar madera en ingles

What is an acceptable difference in the thickness of 2 boards sent through planer one after other.
Will I notice a difference of say .007" at glue up" (.-.)

Looking for ideas on how to set up dust collection on a turret arm radial saw. Don't remember whether or not I already posted something like this way back when. Since last summer, moved and its been slow setting up new shop. Too many other things to attend to first. I've thought about different ways to do the dust collection and have almost decided to just collect it when it shoots straight back and ignore everything else. I have a centralized system with 5" combo of pvc and metal HVAC ductwork. I'm obviously not very clever, hoping someone has come up with a clever way to do this with arm off 90 degrees.... Randy (.-.)

I have the chance to sell my table saw. It's a Rigid R4511 and while it does everything I need at the moment, a better quality saw would make me more comfortable.
Here is where I looked:
Harvey Alpha HW110LC-36P. I've heard great things especially from James Hamilton (Stumpy Nubs) and Julie Moriarty about Harvey, but they don't have a Canadian distributor, so after sale service may be problimatic.
Laguna F2 Fusion Table saw; also attractively priced, shipping and assembly is extra but although there are reviews, I've not seen any discussion here about them.
Sawstop PCS is wildly out of my price range, especially since I just bought a new dust collection system, but the safety factor, and the possible resale value could be interesting.
There are any number of local distributors offering private brands which have some advantages and disadvantages - lower cost but I can't check the quality,and the depreciation is a factor as well.
I'm in my later 70's and while I enjoy woodworking, it's not my profession; cost/benefit is a factor.
I could be interested in an older General, but frankly most around here were used in commercial shops and I really have no patience for rebuilding or searching for parts.
Ah, decisions.
Any thoughts?

(.-.)

Welcome to another issue of Net Interest, my newsletter on financial sector themes. If you’re reading this but haven’t yet signed up, join over 20,000 others and get Net Interest delivered to your inbox every Friday by subscribing here:

Subscribe now

The Long Slow Short

It normally takes a lot less time to destroy a thing than to create it. That’s true on building sites, in careers and of reputations. “It takes 20 years to build a reputation and five minutes to ruin it,” said Warren Buffett. Such is the nature of entropy. 

Yet in business, the reverse can often seem the case. It’s never been easier to start up a new company. In the US, business formation is running at the highest level on record. Companies can be spun up from idea to $2 billion valuation in the space of fifteen months. And, at the larger end of the scale, Facebook is a reminder of how quickly value can be created – this week, it became a $1 trillion company after being around for just seventeen years (I have cardigans older than that!) These companies open new markets and/or promise to disrupt existing ways of doing things.

On the other side though, the incumbents they disrupt can often hold on for a lot longer than anyone thinks possible. Kodak, Blockbuster, Sears – they all took years to be put out of their misery. 

Warren Buffett makes the observation about autos that, “what you really should have done in 1905 or so, when you saw what was going to happen with the auto is you should have gone short horses. There were 20 million horses in 1900 and there’s about 4 million horses now. So it's easy to figure out the losers, you know the loser is the horse.” But you would have needed a lot of staying power to have been short horses. Historic horse prices are hard to come by but, using Buffett’s proxy, the number of horses stayed above 20 million for a further 25 years after he says you should have gone short. 

a.image2.image-link.image2-374-573 { padding-bottom: 65.27050610820244%; padding-bottom: min(65.27050610820244%, 374px); width: 100%; height: 0; } a.image2.image-link.image2-374-573 img { max-width: 573px; max-height: 374px; } The Demographics of the U.S. Equine Population, Emily R. Kilby

One of the reasons there’s a lot more money in venture than in short-selling is precisely because it can take so long for a business to destruct.1

A good example of this on the periphery of financial services is Western Union. I was short the stock once on the Buffett principle that it is easier to identify the loser than pick the winners – in this case in digital payments. I underestimated two things – one, how long the market shift would take to occur; and two, how much free cash flow Western Union would generate along the way.

Actually, there was a third factor that I’ve only recently understood: this is a company that peaked in 1878. My short wasn’t exactly a novel idea! Faced with disruption from the telephone, the fax, the personal computer, the internet, and now digital payments, Western Union has been on a steady decline for over 140 years. When it comes to operating in markets that are collapsing around it, Western Union has form. And yet it's still going. 

This is the cautionary tale of Western Union

What Hath God Wrought?

When Samuel Morse, inventor of the Morse code, sent the first telegram from Washington to Baltimore on May 26, 1844, he ushered in a new communications age. That first telegram read: “WHAT HATH GOD WROUGHT?”

Several companies sprung up around the US to capitalise on the new technology. In 1856, two of them got together to form The Western Union Telegraph Company. The new company snapped up smaller competitors, consolidating its position across the country. Demand for its services boomed and in 1861 the company opened the first transcontinental telegraph wire, allowing messages to be sent near-instantaneously from coast to coast. Before even the railroads, Western Union became America’s first industrial monopoly.

Between 1858 and 1876, Western Union’s capitalization rose from $385,700 to $41 million. Along the way, it introduced the first stock ticker – designed by an employee called Thomas Edison – and launched a money transfer service. When Charles Dow compiled his stock index, Western Union was one of the original eleven constituents. 

But it was all downhill from there.

Things started going awry in March 1876, when Alexander Graham Bell patented his telephone. To bring it to market, Bell sought funding from angels. His father-in-law pitched Chauncey Depew, a senior executive in the Vanderbilt railroad group. Here’s how Depew recalls the pitch (emphasis mine):

One day he said to me: “My son-in-law, Professor Bell, has made what I think a wonderful invention. It is a talking telegraph. We need ten thousand dollars, and I will give you one-sixth interest for that amount of money.”

I was very much impressed with Mr. Hubbard’s description of the possibilities of Professor Bell’s invention. Before accepting, however, I called upon my friend, Mr. William Orton, president of the Western Union Telegraph Company. Orton had the reputation of being the best-informed and most accomplished electrical expert in the country. He said to me: “There is nothing in this patent whatever, nor is there anything in the scheme itself, except as a toy. If the device has any value, the Western Union owns a prior patent called the Gray’s patent, which makes the Bell device worthless.”

When I returned to Mr. Hubbard he again convinced me, and I would have made the investment, except that Mr. Orton called at my house that night and said to me: “I know you cannot afford to lose ten thousand dollars, which you certainly will if you put it in the Bell patent. I have been so worried about it that contrary to my usual custom I have come, if possible, to make you promise to drop it.” This I did.

Depew was clearly not familiar with Chris Dixon’s idea (from Andreessen Horowitz) that the next big thing starts out looking like a toy. If he had been, he could have been very rich. “...if I had accepted my friend Mr. Hubbard’s offer, it would have changed my whole course of life. With the dividends, year after year, and the increasing capital, I would have netted by to-day at least one hundred million dollars.”2

Internally, Western Union dismissed the idea, too:

“This ‘telephone’ has too many shortcomings to be seriously considered as a means of communication. The device is inherently of no value to us.” — Western Union internal memo, 1876.

So Bell and his father-in-law brought the product to market by themselves, creating the Bell Telephone Company in 1877. Before long, Western Union saw the potential of this new technology and went after it too. But amidst a patent infringement case, it pulled out, giving up telephone rights to Bell. (Orton wasn’t just wrong about the toy, he was wrong about the validity of his prior patent.)

Meanwhile, demand for telegraph technology stagnated. By 1909, Bell, now known as AT&T, dwarfed Western Union, and that year acquired it to form an integrated telecommunications company.

Clayton Christensen cites the case as a classic in his theory of disruption:

Alexander Graham Bell’s telephone was initially rejected by Western Union, the leading telecommunications company of the 1800s, because it could carry a signal only three miles. The Bell telephone therefore took root as a local communications service that was simple enough to be used by everyday people. Little by little, the telephone’s range improved until it supplanted Western Union and its telegraph operators altogether.

We’re Not Telegraphers

AT&T only owned Western Union for a few years. Under threat of antitrust prosecution, it spun it back out in 1913. 

Shortly afterwards, Western Union stumbled across the consumer charge card, years before Diners Club and American Express would popularise them. Customers could pop into any one of Western Union’s numerous locations and pay for a telegram on their centralised account. In order to identify the customer to the billing system, Western Union issued them with a small rectangular piece of card, containing the account number, the name and address of the person or company responsible for paying the charges, and a signature line. The card identified the billing account, and the signature could be used to authenticate the cardholder.

Unfortunately for Western Union, it didn’t spot an opportunity to monetise its charge card, even while telephone continued to eat away at its core telegram business.

Domestic telegram traffic dropped from 234 million messages in 1929 to 212 million in 1930 and down to 192 million ten years later in 1940. There was a brief uptick during World War II from military communications, but demand subsequently resumed its decline, falling to 179 million messages in 1950. After the war Western Union struggled to turn a profit.

a.image2.image-link.image2-377-578 { padding-bottom: 65.22491349480968%; padding-bottom: min(65.22491349480968%, 377px); width: 100%; height: 0; } a.image2.image-link.image2-377-578 img { max-width: 578px; max-height: 377px; } Historical Statistics. Notes: Western Union messages 1870-1910; all telegraph companies, 1920-1970.

That didn’t stop Western Union from trying. Under its post-war leadership, the company developed a number of new business lines (oh, but for charge cards): 

💡 The Telex. In 1931, AT&T introduced a teletypewriter exchange service that allowed customers to send and receive messages directly from a machine installed on their premises. Western Union launched something similar, called Telex. The service was a lot less labour-intensive than its core telegram business, allowing Western Union to cut costs. Western Union ultimately acquired AT&T’s service to consolidate the market, taking its footprint from 26,000 terminals to 66,000 terminals in 1968. By the late 70s, Telex took over from telegram as the largest source of Western Union’s revenues. 

💡 Leased communication systems. The company looked to leverage its communications infrastructure by offering turnkey communications networks for government and industry. In 1950, it set up a teleprinter network connecting nearly 200 major banks. By 1960, about 2,000 companies were leasing turnkey communications networks from Western Union. 

💡 Information processing. In the late 1960s, Western Union redefined its market. Its CEO at the time declared about his team, “we’re not telegraphers,” and explained: “We are in the communications service business, but this entails a new concept of communications. We have to broaden communications to include the processing of information as well as the handling of it.” His plan was to install computers at key locations across the country; these computers would integrate telegram and Telex services into a single system, with excess capacity offered to customers to perform real-time information services. 

Underpinning all of this, the company upgraded its legacy pole lines with a network of microwave towers. Later, it launched a series of satellites as well. However, the legacy telegram business did not provide sufficient cash flow to finance the infrastructure build. By the end of the 1970s, the company’s debt exceeded its equity. Meanwhile, one by one the new business lines stumbled.

The strategy to go after information processing was always going to be challenging given the number of competitors. Hundreds of firms from IBM down were addressing the same market. Consumers, where Western Union had an edge, were not that interested and the market didn’t grow that big. The entire online data processing services industry was worth $1.3 billion in 1975, against the $569 million that Western Union was earning in revenue from its core business. Nor were regulators that comfortable with the strategy. The Federal Communications Commission (FCC) wanted Western Union to park the new business in a separate entity and imposed demands on the company in keeping with its monopoly position in domestic telegraphy. In 1976, Western Union's on-line data services revenue amounted to just $64 million.

As for the telex, who remembers those? Subscribers peaked in 1981 at 141,000, the same year IBM released its personal computer. A personal computer plus printer plus modem could replicate the telex and offer so much more. For smaller users, the growth of inexpensive fax machines provided an alternative (but who remembers those?)

Moving Money

Western Union lost money over 1983, 1984 and 1985, partly from investments in an email platform (yes, it was still trying), partly from write-downs on legacy infrastructure. In 1987, investor Bennett S. LeBow acquired control of Western Union through a complex leveraged recapitalization backed by Drexel Burnham Lambert. Over the next few years, Western Union’s management sold off capital assets including the satellite network to Hughes and the Telex network to AT&T.  By 1990, all that remained was a money transfer business, which, in 1994, got sold along with the Western Union brand to First Data Corp.  

The money transfer business had been a sleeper through most of Western Union’s existence. The company processed its first money transfer in 1871. Interestingly, although the cost of telegraphy has come down significantly since then, the cost of money transfer, less so. A copy of an early Western Union transfer for $300 shows fees of $9.34 or roughly 3%. Credit card fees can be as high as that today, and money transfer fees can be higher. 

a.image2.image-link.image2-468-648 { padding-bottom: 72.22222222222221%; padding-bottom: min(72.22222222222221%, 468px); width: 100%; height: 0; } a.image2.image-link.image2-468-648 img { max-width: 648px; max-height: 468px; } Western Union money transfer from 1873

It wasn’t until the mid 80s, when deregulation allowed a previously domestic service to expand internationally, that the business took off. Before that, Western Union never developed sophisticated-enough security – cryptography, identity verification and the like – to make money transfer services core.

First Data spun Western Union back out as a public money transfer business in 2006, a few months after it dispatched its last telegram. Its business model was straightforward. Consumers could take cash into any one of its 270,000 agent locations around the world and have someone else, say a family member, pick it up in another location. Most of the agents are independent businesses authorised to offer Western Union’s services. They provide the physical infrastructure and staff required to complete the transfers and get paid a commission based on a percentage of revenue (shared between the “send agent” and the “receive agent”).

Today, there are 550,000 agents in 200 countries (although 35% of them are dormant). However, while it has broadened its reach, revenues haven’t really gone anywhere. In fact, Western Union came back to the market in 2006 on the back of peak revenue growth (12.5% in 2004 and 2005). Since then, revenues have grown at a compound rate of 0.6%.

Part of the reason for flatlining revenue is price; average revenue per transaction has come down from $28.0 in 2005 to $14.40 in the first quarter of 2021. That includes around a 15% pricing premium versus the market across the entire footprint. But the company is also losing market share. Using World Bank global personal remittance data, Western Union’s share of cross-border money transfers has fallen from 17% in 2008/09 to 14% in 2020. 

And the reason it’s losing share is that yet again, Western Union is being disrupted – this time by digital payments. Wise (formerly Transferwise) lists in London next week (we discussed it here two weeks ago). Although both companies do international money transfer, Wise doesn’t categorise Western Union as a competitor because Western Union deals mostly in cash. The problem is that cash is going the way of the telegraph. 

As before, Western Union is trying. It now does 23% of its business from digital and is on track to do $1 billion in revenue from digital this year. However, although they are digitally initiated, most of these transfers pay out at a retail location so it’s still fundamentally a cash business. 

When Facebook launched Libra in 2019 (now Diem, discussed here) it had its sights on the global remittances market. Its ambitions have been tempered somewhat but whether it’s Diem or other stablecoins or central bank digital currencies (discussed here) or digital wallets, the forces against cash are mobilising. But this is a movie Western Union has seen before. It took thirty years for the volume of telegram transactions to halve, and the same amount of time for the number of horses to halve. It’s a long, slow process. 

Christopher McDonald’s piece, Western Union's Failed Reinvention: The Role of Momentum in Resisting Strategic Change, 1965-1993 was helpful, as was David Hochfelder’s, Turning an Elephant around in a Bathtub. I was told Joshua Elias Lachter’s senior thesis, The Western Union Telegraph Company’s Search for Reinvention, 1930-1980 is good but I couldn’t get hold of it online.

More Net InterestRobinhood/Distressed Investing

When Robinhood received a margin call from the DTCC earlier this year (discussed here), it was forced to raise emergency funding. At the beginning of February, the company issued $3.55 billion convertible notes in two tranches. Of the company’s existing investors, Ribbit Capital was at the forefront of the the rescue, taking down $502 million of the issue, equivalent to 14% of the total; two other investors (Index Ventures and New Enterprise Associates) took another 4% between them. 

When the company goes public, investors in this emergency round will get a large payoff. If the IPO prices below $54.70, the notes they bought convert into Robinhood stock at a 30% discount. One tranche of notes had warrants attached, which exercise at a 30% discount. If Robinhood prices above $54.70 then the notes convert at a fixed price of $38.29, so an even higher discount (in the case of the larger tranche; the maximum conversion price on the other tranche is slightly higher). The notes also carry accrued interest, payable in kind, at a rate of 6%, which adds to the payoff. 

As at end of March, no more than eight weeks after the securities were issued, these securities were fair valued on Robinhood’s balance sheet at $5.04 billion. And that’s with a 10% discount built in. On the day of the IPO, they will be valued closer to $5.8 billion, assuming an IPO price below $54.70. That’s a 62% return over a six month holding period, or $2.2 billion in real money. 

Distressed investing is high return and venture investing is high return, but when the two come together, the returns can be very high. 

Banker hours

In November 2013, Goldman Sachs sent out a memo to its banking staff:

All analysts and associates are required to be out of the office from 9PM on Friday until 9AM on Sunday (begins this weekend)

Earlier this year, in response to complaints from junior bankers, CEO David Solomon recorded a voicemail for staff in which he committed to step up enforcement of the rule.

Now, some researchers have looked at the impact bans like this have on bankers’ work-life balance. Using data from 16 million taxi rides from ten large investment banks to residential destinations, they compare late-night and weekend rides from banks that have adopted such rules to those that haven’t. 

Their conclusion is simple. Bankers who don’t work on Saturdays simply make up for it by staying later during the week. The effect is particularly marked over the summer when interns are on site. At one level, this reflects a classic problem of unintended consequences in regulation, where the response to the regulation is not taken into account in its design.

At another level, it reflects a problem in certain jobs where it is difficult to model individual contribution. Banks have historically used a willingness to work long hours as a proxy for some valuable, yet hard to observe, characteristics of employees. The long hours also create a barrier to entry which solves a selection problem. As Mike Dariano, who alerted me to the paper, notes, “Long hours in investment banking are the Peloton Christmas commercial: not for you. Unless it is. Then it’s really for you.”

Compound Treasury

As you know, I’m being slowly drawn into the web of decentralised finance (DeFi). A few weeks ago in My Adventures in CryptoLand, I wrote about a protocol called Compound. More recently, in Reinventing the Financial System, I wrote:

We spend a lot of time at Net Interest thinking about fintech, which is largely the front end of financial services. Entities like Maker DAO innovate at the back end. When they meet in the middle, interesting things will happen.

This week, Compound launched a new product called Treasury, designed for businesses and financial institutions to access the features of the Compound protocol without dealing with the complexities of crypto. It has already been picked up by neobank Current to offer customers 4% APR on cash balances. In the UK, Ziglu offers consumers something similar (5% on sterling deposits) but it solves the back end by itself. By making the back end easy for all institutions, Compound Treasury is a step towards the convergence of DeFi and traditional finance.

1

One example of a sudden corporate decline (outside of fraud) is the case of Ratners, a chain of UK jewellery stores. In April 1991, its chairman, Gerald Ratner, made a speech where he said, “People say, ‘How can you sell this for such a low price?’, I say, ‘because it's total crap.’” He went on to say that one set of earrings on sale was “cheaper than a prawn sandwich from Marks & Spencer’s, but I have to say the sandwich will probably last longer than the earrings.” After the speech, the value of his company fell by around £500 million and never really recovered. However, the episode occurred during a recession when consumer spending fell at its highest rate in at least twenty years, so it is difficult to isolate just how much of the demise was caused by Ratner’s comments.

2

Despite missing out on at least one hundred million dollars, Chauncey Depew imparts great advice: “I have no regrets. I know my make-up, with its love for the social side of life and its good things, and for good times with good fellows. I also know the necessity of activity and work. I am quite sure that with this necessity removed and ambition smothered, I should long ago have been in my grave and lost many years of a life which has been full of happiness and satisfaction.” — Depew, Chauncey M. (Mitchell), My Memories of Eighty Years, Published 1922

What do many cryptos, cannabis stocks, precious metals stocks, and SPACs all have in common?

The answer might not be obvious at a glance.

But if you’ve personally invested in any of the above before…

Or if you’re familiar with the story of the GameStop short squeeze…

Then you might have a good idea of what the answer is already.

Know Your Risks

When you decide to invest in a particular stock or asset, it’s not enough to simply know what the drivers and catalysts are.

You must also understand the risks.

Risk management is a complicated and in-depth topic.

There are many different types of risks –

• sovereign risk,
• time horizon risk,
• market risks, and many more.

Also important is this: Each investor’s risk profile is different…

The single young investor with stable income and no dependents or mortgage has a much larger appetite for risk than a household’s primary breadwinner with children to take care of, college tuition fees on the near horizon, and a hefty mortgage on the house that needs a major reno.

But setting all of that aside, today we’ll be focusing on a single kind of risk in particular – one that has reared its ugly head time and again to thwart the efforts of many a would-be investor.

I’m Talking About Liquidity Risk…

Quite often, when a particular new sector or asset class hits it big, there’s a massive run-up in prices that causes investors to pile on.

And there’s no sexier story to jump onto than a small-cap company or – lately – crypto ICO.

Small-cap companies are the fresh draft picks on a championship finals team, the underdog stories that everybody loves to cheer on.

Compared to the senior, more well-established companies in their sector, they’re much cheaper, thinly traded, and usually have no analysts following the story… It often means that they have more room for dramatic share price moves if they hit it big.

Apple isn’t going to be providing shareholders with 10x returns in a short time frame. It’s too large, its assets and revenue streams too well understood for that kind of crazy jump in valuation.

But a small-cap biotech company worth pennies? They might just have the idea that’ll turn them into the next Pfizer or Moderna.

Small-cap companies and sh*tcoin crypto’s are a dime a dozen, and many of them never make it past the planning stage.

But when an entire sector takes off, like back during the cannabis and crypto rushes we’ve seen in the last few years, many coins and companies often get lifted up to the top by the rising tide.

For instance, back three years ago, marijuana was on the up-and-up. With volume through the roof and prices flying high, things were looking good. The bankers were flying, high up on their own smoke clipping fees.

But then the other shoe dropped:

• As you can see, prices collapsed over the next few months… and trading volume dried up alongside the meteoric fall in prices.

Here’s the chart for a sample junior (small-cap) cannabis company during that same time frame:

Though there was plenty of volume for this stock at the beginning of 2018, you can see that trade volume tapered off rather quickly.

And by mid-2018 it would’ve been very difficult to exit a large position in the stock.

• Be wary of your paper gains evaporating ultra-fast when liquidity (volume) dries up.

And if you’d decided to buy in, or worse, average down, late in 2018 when volume briefly spiked up… you would’ve been left in even worse shape.

Only months later, by the spring of 2019, trade volume had all but completely dried up.

This hard lesson learned by the crowd in the cannabis boom was felt in early 2021 after many tech stocks experienced a liquidity freeze.

Don’t Get Left Holding the Bag

As mentioned earlier, this is a story I’ve seen once too many times – in precious metals, SPACs, and cryptocurrencies, and cannabis, among others.

Don’t fall for a bearded geo with a box of crayons, a map, and a fistful of promises urging you to “double down and average down”.

In the absolute worst-case scenario, a company that needs to raise money will get its share price wiped up during a period of a liquidity freeze.  The dilution that will occur to the shareholders will essentially wipe out much of the value you thought you had.

A similar analogue for cryptocurrencies would be coins that aren’t being used or developed any longer – you won’t be able to find any buyers for your failed crypto coins.

All too often, amateur investors experiencing their first big win will ride that paper high. (Dogecoin anyone??).

They’ll look at their account statements and feel euphoric over the big numbers and triple-digit gains they see, without understanding one fundamental fact:

• Until you sell, you haven’t made a single penny.

When it comes to my premium newsletter service, Katusa’s Resource Opportunities, I’m not just about delivering the best stock research and picks to my subscribers.

There are simple rules to ensure you do not experience a catastrophic loss.

When you’re overleveraged, can’t sleep at night because of your position sizes, or hold little cash capital – you’re setting yourself up for the potential of a catastrophic loss.

Unless you have a biblical tolerance for risk in crisis situations, you’ll get crushed.

• Keep in mind that 99.99% of people who can fog a mirror should not use any leverage tools for investing.

Taking a mortgage or line of credit to invest in the markets or cryptos is taking excessive risk in any sector. You will set yourself up for hardship and a lot of personal strain; even if it works out.

If you are jeopardizing your standard of living for yourself or your family, don’t even consider it.

There are many ways to reduce your risk and amplify your upside.

I also want to educate my readers, with best practices like the Katusa Free Ride:

By applying the Katusa Free Ride Formula appropriately…

You can reduce your exposure to liquidity risk – and many other types of risk – simply by taking your initial capital off the table.

Here’s how it works…

To learn more about managing your investment portfolio’s risk, as well as to find out what I believe is going to be the largest wealth creation opportunity of our lifetime, consider subscribing to Katusa’s Resource Opportunities.

It’ll be the most risk-free educational investment course you’ll ever make in your life.

Regards,

Marin

The post The MOST Dangerous Trap in Every Investment Market appeared first on Katusa Research.

Welcome to another issue of Net Interest, my newsletter on financial sector themes. This week’s issue is a bit different – it’s a guest post by Bruce Packard. Like me, Bruce is a former equity research analyst; in fact we used to work together at Credit Suisse. I’ll introduce him properly below. In the meantime if you’re reading this, but haven’t yet signed up you can do so here:

Subscribe now

Litigation Finance

An occasional theme here at Net Interest is the study of new asset classes. There’s something quite fascinating about them: how and why they emerge, why some endure and some don't, the types of people who pioneer them and the money they make and lose doing so.

It's hard to believe now, but equities were once a new asset class, at least in institutional eyes. A few years ago some finance professors conducted an appraisal of John Maynard Keynes’ performance as manager of his Cambridge college endowment from 1921 to 1946. Keynes’ top-down macro approach generated disappointing returns in the 1920s, but when he switched to stocks – not permitted by many other colleges until later – his performance improved. “Keynes’ great insight was to appreciate the previously overlooked attractions of a new asset class for long-term investors, namely equities.” 

Since then plenty of new asset classes have sparked institutional interest. We’ve discussed here some contemporary ones – crypto of course, and also revenue contracts; we’ve also discussed one that didn’t endure – supply chain finance. With interest rates so low, the demand for alternative asset classes offering i) higher returns and ii) uncorrelated risk has never been higher, making this a ripe environment for new asset classes to incubate. 

This week, we take a close look at another new asset class – litigation finance. And there’s no-one better to introduce us to it than Bruce Packard. A couple of years ago, Bruce spent some time working with a mutual friend who was setting up a litigation finance crowdfunding platform: Axia Funder. Today, he writes a weekly column for Sharepad. 

Over to Bruce.

Size of the market

The size of the legal market is huge. The top 30 law firms have $2 trillion of pending arbitration claims; annual law firm fees are $860 billion globally (of which just over half is in the US). Both corporates and law firms expect the market to grow further as disputes rise following the pandemic, according to a research survey published by Ernst & Young.

One such dispute is the case between Tatiana Akhmedova and her son, Temur. The case erupted after Temur had conspired with his father to hide assets following his parents’ divorce. In April this year in London, a High Court Judge, Mr Justice Knowles ruled in favour of Tatiana. Temur was ordered to pay his mother £75 million. The court heard how Akhmedov senior transferred assets such as their superyacht, Luna (worth around £340 million) and an art collection (worth around £110 million) into the ownership of trusts in Liechtenstein in order to prevent his ex-wife receiving £453 million that she had been awarded following the couple’s divorce.

Burford Capital, a new type of law company that funds court cases, is helping Tatiana recover these assets from her ex-husband and son. Disputes like this should be uncorrelated with other asset classes such as Government bonds or equities, which all respond to economic cycles. Indeed disputes tend to be unique in nature, and should be uncorrelated with each other. There’s little to suggest the pursuit of the Akhmedov yacht should be correlated with another of Burford’s claims – against the Argentinian Government over the expropriation of an oil company (YPF).

What are legal assets?

For industrial companies, property, plant or equipment make up the bulk of assets recorded on their balance sheet. But financial companies’ assets are more abstract, such as loans like mortgages or bonds, with the debt often secured on tangible assets like property. Companies like Burford take this one step further, and offer non recourse funding of legal claims in return for a share of the money recovered when the dispute is settled. This is inherently risky – court judgments can go against you, even if your lawyers believe you have a strong case.

If the claimant loses, they (and the litigation funder) receive nothing and may have to pick up the other side’s costs. Therium, an unlisted litigation finance company, has suffered a couple of high profile losses. One involved a drunken bet made in the Horse and Groom pub between Sports Direct owner Mike Ashley and banker Jeffrey Blue; Jeffery Blue lost and had to pick up Mike Ashley’s costs. Another was the case brought by Amanda Staveley against Barclays over the bank’s 2008 fundraising. Both cases highlight the risk in litigation finance: the outcome tends to be binary – either a large gain or zero. 

Burford says that they lose just 10% of their cases. They win 29% of their cases in court, but the majority of cases, 61%, are settled before going to court. Burford doesn't own the case, they provide the funding, so it is the plaintiff’s decision whether to settle out of court for less money, or go to court and receive a likely higher reward, but at the risk of losing, and receiving nothing. 

Tatiana Akhmedova and her attempts to impound Luna reveals that litigation finance isn’t just about the judge ruling in a claimant’s favour. Defendants often hide assets overseas to evade court orders and some jurisdictions are friendlier than others. Imagine trying to enforce an English court’s award against a Russian oligarch in a Russian court. Asset tracing and recovery are therefore also integral to successful litigation finance.

Burford is the only major litigation funder to keep an asset tracing and recovery team in-house; most funders outsource this activity to firms run by ex-intelligence agents and private investigators. Christopher Bogart, Burford’s CEO, says: “Enforcing judgments is core both to the integrity of the legal system and the success of a litigation finance business. In some cases, scofflaws try to evade payment of court judgments and their obligations.” (I had to look up the word “scofflaws” but it is a word, meaning: a person who flouts the law, especially by failing to comply with a law that is difficult to enforce effectively.)

Sometimes asset recovery can lead down unusual paths. Harry Sargeant, a US billionaire, accused Daniel Hall, who works for Burford, of illegally accessing highly personal materials, stored on a corporate server belonging to the family business. Burford was trying to enforce a $29 million judgment against Sargeant and presumably Hall believed that this would be more likely if he had obtained a compromising video tape of the billionaire.

Returns

Common sense would suggest you don’t see high returns without any risk. At first glance the numbers look very attractive in a low yield environment. Burford reports that on $831 million worth of disputes that they have funded with their own balance sheet since 2009, they have generated a ROIC of 92% and an IRR of 30%. A competitor, Litigation Capital Management reports an even higher ROIC of 135% and an IRR of 78% over the last 9.5 years.

As you would expect, high returns attract new entrants. The Association of Litigation Funders lists 13 members, including Burford, Harbour, Vannin and Therium. Most firms remain confident that competition should not drive down returns, as this is a relationship based business, with law firms tending to recommend the funders who they have successfully worked with in the past. 

That may be true, but it’s rare to find an industry where a large inflow of capital does not alter the economics of returns. Like banking and insurance, there will be several years’ time lag between new business written and rewards (or losses) reported. Litigation funders that are writing business based on optimistic return assumptions can do so for several years before the chickens come home to roost.

Accounting

A separate criticism of high reported ROICs, is that the returns are illusory and the sector has opaque accounting. It is important to understand that c. 100% ROICs that funders report is not comparable with the mid to high teens returns that companies like Unilever report. The litigation finance companies report the ROIC on a portfolio of completed cases and exclude i) cases where money has been invested, but have not yet settled and ii) allocating their group operating costs.

Importantly, Burford and its critics do not disagree on the numbers, but how the numbers are presented. By way of example, Burford’s 92% ROIC calculation is based on $831 million capital deployed in completed cases, from which they’ve recovered $1,597 million. Simple. Yet if we sum up all of the capital deployed using the table on page 45-46 of the 2020 FY Annual Report, the sum comes to $1.8 billion. The roughly $1 billion difference represents those cases that have yet to be completed. Should the “Invested Capital” denominator include all capital that has been invested, or just that from completed cases? I think that you can make the case for both calculations; what is important to understand is that the high ROIC figures reported by litigation finance companies are not comparable with what companies in other sectors report.

Burford has a market cap of $2.4 billion versus a total portfolio of $4.5 billion of disputes, though that contains both funds managed for third parties not on their balance sheet and cases that have been written up using Fair Value accounting. Critics have suggested that Burford is quick to write up gains with Fair Value accounting, but slow to recognise losses. Originally Burford management were not keen on Fair Value accounting, in 2010 they said:

“[We] believe strongly that litigation and arbitration returns are inherently speculative and are most appropriately accounted for by holding investments at cost until a cash realisation has occurred, as opposed to taking unrealised gains into income before a litigation resolution has occurred. Moreover, the appropriate metric, in our view, for Burford Capital’s share price measurement is its relationship to net asset value based solely on actual cash realisations. Thus, for the guidance of investors, we publish a cash NAV figure alongside the requisite IFRS-based NAV, and we encourage investors to consider the cash NAV as the appropriate valuation metric.”

Then something changed. In 2011 Annual Report, Burford stopped publishing cash NAV, claiming that:

“We have also historically published a “cash NAV”, but that measure has not been embraced by analysts and investors, and given the increased complexity in its computation following the Firstassist acquisition and the relatively modest and clearly identifiable unrealised gain in the portfolio, we do not intend to continue to use or publish it after this set of accounts.”

Study silence to learn the music

Voluntary disclosure – what companies choose to tell investors – rather than what they are required to reveal, is a fascinating area. And very often when companies change their mind and withdraw disclosure it’s even more significant, though harder to spot. When you walk around the City of London and see large cranes and a new building going up, it’s often hard to recall the building that previously stood in the space. Similarly, unless you are reading corporate results laid out with the previous year’s results in parallel, it’s hard to see what is no longer there. Or, as the Finnish Operatic Metal band Nightwish sang: I studied silence to learn the music.

Perhaps a coincidence, but around this time is when Selvyn Seidel, the co-founder who lived in the village of Burford, left the company. The other co-founder was the current CEO, Christopher Bogart, previously General Counsel for Time Warner and before that Cravath, Swaine & Moore. 

Burford’s IPO in 2009 was backed by Neil Woodford, while he was still at Invesco Perpetual. He bought 45% of the share capital when the shares IPO’d at 100p, which required a special waiver from the Takeover Panel, as over 30% would normally require a mandatory bid for the entire company. This valued Burford at £80 million market cap in October 2009. Other institutions with disclosable interests were Baillie Gifford, Fidelity, Eton Park and Scottish Widows. Most of those investors have sold out now, Woodford’s fund has been wound down, Invesco owns just 6% and currently the largest shareholder is Saudi Arabian fund, Mithaq Capital, with 10.5%. 

Short selling attack

By October 2018, Burford’s share price had risen from its 100p 2009 IPO price to almost £20, and the company raised £192 million (or $251 million) at 1850p per share. Canaccord published a sell note in April 2019 and in August 2019, Carson Block of Muddy Waters led an attack on the company, calling it “a perfect storm for an accounting fiasco.” Block has made a name for himself shorting Chinese frauds: Orient Paper, Sino Forest, Luckin Coffee. He has been aggressive and he has been right. In his report he compared Burford’s accounting to Enron. Block also highlighted the fact that Christopher Bogart’s wife, Elizabeth O’Connell was the CFO, though she has since been replaced by Jim Kilman, formerly Burford’s investment banker at Morgan Stanley.

Muddy Waters can claim victory in their battle: Burford’s share price fell back below £3 in March 2020, helped by a broad sell off in markets due to the pandemic. Following the attack, Burford disclosed that they have written up the value of their court case against Argentina for expropriating the oil company YPF to $773 million. The firm’s rationale is that there is a secondary market in this large claim; they sold 39% of their interest in the proceeds of the YPF/Petersen claim for $236 million in cash in a series of third-party transactions from 2016 to 2019. Burford management says that Fair Value accounting requires them to write up the value of the asset. 

Many twists and turns

Burford’s share price has now recovered to 780p.  Last week they announced that they had bought back £24m of bonds yielding 6.5% due 2022, which does not appear to be the actions of a company that is worried about its financial position. It’s possible that they do recover a significant sum from the Argentinian Government in the next few years, which would justify management’s accounting. The case against Argentina will be heard in New York, probably at the start of 2022. Lawyers with large value disputes are tenacious, many of their cases take years to come to judgment, with many twists and turns. The jury is still out.

Share Net Interest

Subscribe now

More Net InterestStress Tests

US banks have a lot of catch-up to do. Last year they were restricted from increasing dividends and doing share buybacks as regulators encouraged them to preserve capital. This week, they all passed their stress tests, with ample buffers against regulatory capital minimums. In aggregate, the banks that participated in this test have around $175 billion of excess capital, equivalent to around 10% of their market cap. Compared with their own capital targets, which are typically more conservative than regulatory minimums, they have around $100bn of excess capital.

Although the stress applied to banks in these tests was not as severe as last year, when the outlook was more uncertain, it remains a pretty severe test. The Fed stressed credit card loans at a loss rate of 16.2%, much higher than what was incorporated into stress tests five years ago (13.4%) and a big gap versus the rates currently being realised. In commercial real estate, where risk might be more apparent today, losses were estimated using a 10.5% loss rate, which is the highest ever used in a Fed stress test (last year a rate of 6.3% was used). Yet the banks are quite well covered and already have a large stock of provisions to absorb such high losses; the top seven banks have sufficient provisions to cover around half of their stress-case losses before capital even has to be tapped into (last year that coverage was only around a quarter). 

Banks will report capital plans on Monday (28 June). They will be eager to disgorge their excess capital to shareholders. 

Revolut

I’ve discussed Revolut here a few times before, and I’ve been remiss – I should have disclosed that I’m an investor; I participated in the series A back in 2016. However, first and foremost I’m an experienced analyst and that stops me being starry-eyed. This week the company filed its 2020 financials and they are a bit mixed. 

The company lost £168 million on revenue of £261 million (including fair value gains on cryptocurrencies). Between those two numbers, there’s a lot of cost. Much of that is linked to risk, compliance and control enhancements. Based on LinkedIn data, around a sixth of the company’s workforce (of ~ 2,500) now sits in some sort of compliance function. The good news is that those costs are largely fixed and don’t have to scale with the company. Nor do the total costs include much marketing. The company halted marketing and discretionary spending during the year, yet continued to win new customers largely by referral (customer count is 15 million as at March 2021, up from 10 million in February 2020). 

Revenues have diversified. Just over a third of revenue now comes from card and interchange, compared with just less than half in 2019. Crypto picked up the slack which may now be taking a hit, but the company also opened up a source of income via subscriptions which now contribute 29% to revenue. Subscriptions are good because the rest of the revenue base is very transaction oriented; there’s no interest income here. In fact, average deposits per customer stand at around £300, much less than at Wise, where they stand at £2,300, so scope to earn substantial recurring revenue from them is limited (notwithstanding the current level of interest rates). Average revenue per customer of £21 for the year is not great, although there is likely a distribution around that number (how many of the 15 million customers are not active?)

Despite the company’s grand ambitions to expand globally, most revenue still comes from the UK – 88% of statutory revenue in 2020 (i.e. excluding the mark-up on crypto). By the end of the year, Revolut had 200,000 customers in the US, where it intends to make a push. 

Press reports indicate that Revolut is looking to raise capital. Part of this may be to fund regulatory capital to underpin the bank licenses the company has applied for in the US and the UK. Klarna has been regulated as a bank since 2017 and has had no trouble raising capital, but its core product is higher return than Revolut’s. Key will be whether Revolut can use its banking licenses to win more deposits and introduce more products. 

Tink/Visa

Visa announced this week that it would acquire Tink, a European open banking platform, for $2.2 billion (versus its last valuation of $825 million in December). Founded in 2012, Tink offers customers access to underlying consumer financial data via a single API. It reaches over 250 million consumer bank accounts across 18 markets in Europe via integrations into over 3,400 financial institutions (versus ~11,000 market total). It offers five key products: Transactions, Account Check, Income Check, Payment Initiation and Money Manager. 

Account-to-account payments are growing as a credible alternative to payments made via card networks, particularly given the support of unified protocols such as Open Banking in the UK. This deal gives Visa a foothold in the segment. Open banking payments are better suited to large ticket items since fees do not scale with transaction size, and to transfers between a consumer’s various accounts (e.g. bank to fintech). They may also be better suited to variable recurring payments compared with cards kept on file. Depending on the underlying payments network, settlement times can also be faster, such as in the UK under Faster Payments. 

Visa was exposed by the DOJ when it tried to buy Plaid. It is unlikely that there will be an incriminating email trail this time (or back-of-the-napkin doodles of volcanoes) but the motivation is similar: to own control of the disruptive play rather than look on passively.

It’s a cunning strategy.

The US Federal Reserve satisfies the global demand for dollars while maintaining the dollar’s title as the planet-wide currency king.

With one brilliant move, it has divided the world up into allies and non-allies of the US.

Today, everyone needs the stability of the USD in a world turned upside down with economic turmoil.

Granted, that stability may be only relative to other countries’ own currencies. But American allies have to deal with that reality.

They know it. And the Fed knows it.

• That’s why the Fed has created a path to access US Dollars for government-identified real allies of America.

And it has denied access to those identified as unfriendly.

It’s critical that you understand this…

And when you do, you’ll be miles ahead of almost everyone else.

The US has put a system in place where all but the most die-hard anti-American nations will want to be included among the friendlies.

In fact, many will do anything to make the list. How do they do this? Through SWAP lines.

Never heard of them? Then you’re not alone.

For the most part, when I bring up SWAP lines, I have found myself speaking into a vacuum.

I haven’t come across one person in a hundred that knows about them. And that includes business executives, politicians, or even bigshots in the financial industry itself.

Most investors are not even cognizant of the program’s existence, much less aware of its significance.

But given how important SWAP lines are to the global economy, every investor should understand them and how they work.

What Are SWAP Lines?

First things first, here’s how the Fed explains swap lines on its own website:

• If you have access to a US swap line, you are what I call a +SWAP Line Nation.
• If you don’t have access to a swap line, you are a -SWAP Line Nation.

SWAP Lines Are a Financial Lifeline

In the wake of any global panic, the most recent example being the pandemic…

Many central banks request that America provide financial assistance to at least alleviate the stress caused by a lack of US Dollars.

SWAP lines have provided that relief and will continue to do so.

They are, literally, lifelines. And they are also debts.

• All those dollars borrowed must be paid back in US Dollars, with interest, also requiring dollars.

It’s ingenious because demand for the US Dollar breeds further demand.

It will be paramount for nations grappling with deflation to enter the favored group capable of exercising swap lines.

Here’s a list of the nations that have access to US Dollar SWAP lines (as of now):

Countries outside the group—the negative swap line (-SWAP) nations—will struggle to access US dollars.

SWAP Lines are Important for Investors

The result of how this program is set up is that countries receiving swap lines will follow any stipulations they are asked to follow. They’ll have no choice.

• Suppose you want to be blessed with a swap line from the U.S…

In that case, you must be careful not to antagonize the hand that feeds you.

This means not aligning in any way with nations designated as non-friendly and agreeing to follow any restrictions, such as sanctions, that the US government puts on.

The struggling nations that require emergency access to US Dollars, and can’t get them…

• Could engage in the expropriation of foreign-owned assets as the world recession deepens.

For example:

Last year Papau New Guinea revoked Barrick Gold’s social license. Several months ago, Barrick gave the PNG government a 51% stake in the mine. Now the mine is back in production.

The PNG government is not the only nation flexing its muscles…

• Chile is amidst altering its tax code which could see miners be taxed up to 75%

• And just recently, Kyrgyzstan seized Centerra’s Kumtor gold mine.

It’s either that or face crippling depressions or revolutionary uprisings of their citizens (or both).

So, American businesses with operations in these places had better beware (and so should their investors).

SWAP Lines Will Defend American Interests

As global deflation progresses, there will be more nations that will be granted swap lines. But do not forget, swap lines will always defend American interests.

Make no mistake, this is big business…

• By April 2020, the drawdown of USD SWAPS was just under half a trillion dollars.

The last time that foreign central banks took down that amount from US SWAP lines was at the height of the 2008 global financial crisis.

The SWAP lines worked back then to prevent a complete worldwide financial meltdown. Same thing now. But this is just the tip of the iceberg.

Few want to be shut out, and around eighty-five nations have applied for US swap lines (currently, 14 central banks have been approved (EU representing 27)).

In fact, Indian Prime Minister Narendra Modi has publicly confessed to having “swap line envy.” To be approved, all those countries must solidify their positions as US allies by falling into line with our policies.

Think they will? Yep, me too.

More Nations Will be Added

Over time, I expect these critically important SWAP lines to be increased and more nations to be slowly added.

They’ll be subject to the terms set by the US government—both financially and geopolitically. But they’ll accede.

As monetary and fiscal policy are blending into one, it’s just a matter of time before the President uses SWAP lines as a big geopolitical leverage hammer.

SWAP lines are that important, and they will dictate global alliances and policy. So, pay attention to them.

Because I promise you, they will have an impact on companies, investments, and ultimately, the very fabric of our world.

• If you have a producing asset in a Negative SWAP Line (-SWAP) country, you must prepare for potential setbacks and for things to go wrong.

It’s about properly understanding and pricing in risk.

Something that has become overlooked in the resource sector.

SWAP Lines and Your Portfolio

Because I believe nations who do have existing SWAP lines won’t screw with foreign operating entities (American companies) to the extent of the –SWAP Line Nations.

I still expect higher taxes in all countries as it’s the only thing politicians across the world have executed effectively throughout time.

This means mining assets in +SWAP Line Nations won’t nationalize their gold mines, copper mines etc. Those nations won’t screw with America.

Nations with existing U.S. SWAP lines won’t put Forex (FX) restrictions on the foreign (American) companies operating there. –SWAP Line Nations may do so, and many have already.

This will cause less (and in some cases prevent) those U.S. Dollars in –SWAP lines from being sent back home as dividends to the owners of the company.

Know the plan. Read the playbook.

And most of all, be prepared. You can get my team and me to do the heavy lifting for you through my premium research service – Katusa’s Resource Opportunities.

I’ll tell you exactly what I’m doing – where I’m investing – and how you can follow.

Regards,

Marin Katusa

The post SWAP Lines are One of the Most Important Things You’ve Never Heard Of appeared first on Katusa Research.