JPMorgan (JPM) And Wells Fargo (WFC) TARP Warrants To Surprise On The Upside For The Next Seven Years; Leveraged Value Play In Portfolio Of Top Value Money Manager
November 1, 2011 - The Wall Street Transcript has just published Value Investing And Investing Strategies Report offering a timely review of the General Investing sector. This Special Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. Please find an excerpt below.
Whitney R. Tilson is the Founder and Managing Partner of T2 Partners LLC and the Tilson Mutual Funds. T2 Partners manages three value-oriented private investment partnerships - the T2 Accredited Fund, the Tilson Offshore Fund and the T2 Qualified Fund - and Tilson Mutual Funds is composed of two value-based mutual funds, the Tilson Focus Fund and the Tilson Dividend Fund. Mr. Tilson is also the Co-Founder, Chairman and Co-Editor-in-Chief of Value Investor Insight, an investment newsletter, and is the Co-Founder and Chairman of the Value Investing Congress, a biannual investment conference in New York City and Los Angeles.
TWST: How about a position you've taken?
Mr. Tilson: As I mentioned earlier, having avoided the big declines, we've been bottom-fishing in the financial sector and have been aggressively buying a number of positions. The ones we own right now are Goldman Sachs (GS), Citigroup (C), Wells Fargo (WFC) and JPMorgan (JPM). We own the JPMorgan and Wells Fargo positions via TARP warrants, very unusual securities that were created when the U.S. government invested in these institutions during the financial crisis. The government not only got its money back, but also got long-dated warrants that don't expire until 2018. They're currently out of the money - the strike prices are above today's share prices - but you've got about seven years before they expire, so we think this is a very interesting and leveraged way to bet that JPMorgan and Wells Fargo will do well over the next seven years. In the case of Goldman Sachs, the stock trades at about $104 per share. We started buying it as high as $112 per share and kept buying all the way down to the very bottom under $85.
The company currently has more than $120 per share of tangible book, so today it's trading at a 13% discount to tangible book value. Thus Goldman Sachs is being priced as if it is worth more dead than alive, which is crazy. It is being priced as if the company's business model is permanently broken, and that it will never be able to earn its cost of capital going forward. Yes, the company just reported a loss in Q3, and the market is very bearish on when Goldman will turn the corner to profitability or whether it ever will. Our view is the opposite. One of the reasons Goldman lost money last quarter is because they reduced risk. They were very defensively positioned. We like to invest in financial companies that anticipate trouble coming as Goldman did - the world has been very turbulent last few months - and take down risk.
In summary, we think that that when all is said and done, a year or two from now, Goldman will be the premier investment bank in the world, and that it should be able to earn at least 15% return on equity. It will never earn the 20% to 30% return on equity it did during its heyday, but we don't need it to, owning the stock at 87% of tangible book value.
As for Citigroup, it's a fabulous business tied to a runoff business. Think of it as good bank, bad bank. The company has officially split into Citicorp, good bank, and Citi Holdings, bad bank. The latter has all of the U.S. mortgages, second liens and other troubled stuff, which represents about 17%, or $289 billion out of the company's total balance sheet of about $1.65 trillion. It's only 17% of the company's assets, but it's still very large. As a standalone business, Citi Holdings would be the seventh-largest financial institution in the U.S. Investors are so worried about potential losses in Citi Holdings that they are ignoring two things. First, the company has $32 billion in allowance for loan losses plus over $140 billion of tangible equity. So we think the company is financially strong and can withstand anything but a worst-case scenario without raising additional capital. The second mistake the market is making is not giving appropriate credit for Citicorp.
A critical question always is: What price are you paying? Citigroup is much cheaper than Goldman on a price-to-book basis. The stock right now is at $31.60, and book value is $49.50. This is tangible book, not counting good will or other intangibles. So Citigroup is trading at a 36% discount to tangible book, and we think fair value for something like Citi is around book value. So to appreciate from today's price up to what we believe is fair value is more than a 50% gain in the stock.
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