01/2019 Market Commentary



Netflix (NFLX) has a new CFO and his first objective is to address the cash flow conundrum. The company’s cash flow is negative because it spends more than it takes in. Netflix is buying and building content at a rapid pace – while the payoff profile of the content occurs over an extended period (and often does not begin for at least two years). This means NFLX will not know if its strategy is successful until it is too far the wrong way. Most peers grow at a much slower pace and can rely on cash flows from existing content to fund content development. Investors in Netflix’s stock and bonds are risking their capital on the prospects of the returns on the content. Time will tell, but Ballast thinks its unwise to place high value on something that is unproven, unpredictable, does not cash flow, and whose outcome is several years into the future.


Netflix did notch one victory. The film Bird Box was a major success – at least based on viewership. It is important to note that the movie is not pay-per-view so its comparison to traditional film release via movie theaters is not possible. It may be a case study in how the future of movie release and promotion will look. The film’s success was the result of viral social media promotion among other things.


Also happening in January was Netflix’s announcement that it would raise subscription prices. NFLX stock price roared on the news. Then, the company’s earnings were released, and the stock price fell back to earth as analysts were disappointed by earnings. NFLX is growing revenue but it can’t seem to meaningfully grow earnings. Some conundrum…




Another month of headlines. We will stick with recent months’ format and list some top stories with minimal comments:


General Electric


As GE dismantled what was the financial operations of the company over the past few years, there were a few units that would always be retained. GE Capital Aviation Services, or GECAS, was one such unit. January brought the possibility that the unit would be sold, and it attracted a trove of private capital to bid. The unit’s fate is yet unknown, but it is expected to fetch as much as $40 billion. GECAS is the largest aircraft leasing company in the world – bigger than Air Lease Corp and AerCap – leasing to the world’s major airlines. It appears nothing is sacred to the new CEO, Culp, as he works to deleverage the company. GE’s challenges remain, nevertheless.




Pacific Gas & Electric (PCG), California’s largest utility company, filed for bankruptcy after careful consideration of its liabilities. It was a volatile month for PCG. As required by California law, PCG announced 15 days in advance of filing for bankruptcy that it intended to file towards the end of January. By the end of the month it did so, despite state investigators finding PCG not at fault for the wildfire that caused significant damage to Napa Valley and surrounding communities in 2017 (Tubbs Fire). What remains, though, is the liability from the 2018 wildfire, Camp Fire, which is estimated to be as much as $30 billion (an amount less than the implied equity value of PCG before the fire). So many equity investors are left wondering why PCG has filed for bankruptcy. Our thoughts are many but here are a couple primary thoughts:


1) Liquidity – Although PCG appears to be solvent, it is short on liquidity and would be in that position for a prolonged period (whereas bankruptcy will allow the company to recapitalize to a structure where liquidity is built-in).


2) Efficiency – The process of litigating and settling $30 billion in claims would be time consuming, cumbersome, and lead to volatility (whereas filing for bankruptcy brings more order).


Jack Bogle


Jack Bogle passed away in January. Jack was one of the fathers of passive investing, having founded Vanguard, the investment manager eponymous with low cost index funds. At the helm of Vanguard, Jack set off a revolution (and an industry-wide trend of cutting investment fees) as more investors came around to Jack’s passive investing. No one has perhaps done more for investors than Jack – through Vanguard. Jack, we salute you.




January was a tough month for the Brazilian miner, Vale. A tailings dam it was working on decommissioning failed, killing nearly 100 people and requiring substantial environmental cleanup. This isn’t the first dam failure for the company. Three years ago, a joint venture of Vale (called Samarco) experienced a dam failure that led to 19 deaths and several billion dollars in damages. To compound matters for Vale, the company has numerous other mines with potentially problematic tailings dams. Vale has taken the bold step of significantly reducing production at those mines and will decommission the dams over the next three years. The initiative will cost as much as $5 billion, and although all dams are characterized as inactive, Vale will have to cut back on production. The combined costs of cleanup and decommissioning acutely shifted Vale’s credit profile. Vale has suspended its dividend, and its credit ratings are under review for downgrade. Ballast is monitoring the situation for investment opportunities.




Abbvie (ABBV), a major pharmaceutical company that was spun out of Abbott a few years ago has suffered a few setbacks in recent years as it tries to shift away from a concentrated revenue stream (the majority of which come from sales of blockbuster drug Humira). Pushing its drug development pipeline to growth and shifting away from Humira, AbbVie has made several acquisitions lately. One such acquisition was Stemcentrx for $10.2 billion($5.8 billion cash and stock with the rest in milestone payments). Fast forward two years and ABBV announced it would take a $4 billion charge when the key drug that they acquired failed in clinical trials. Several peers have had similar experiences lately.


Bristol-Myers Squibb (BMY) announced that it would acquire Celgene (CELG) for approximately $74 billion. By comparison, BMY had a market capitalization of $81 billion. This is a large acquisition. The break-up fee for the acquisition was set at $2.2 billion. Ballast has discussed CELG in the past and highlighted its tough path forward. This transaction is a major bailout for Celgene, whose share price fell from $145 in late 2017 to a recent low of $59. Because the challenges of Celgene’s drug portfolio remain, this transaction could spell disaster for BMY if completed. BMY will increase leverage to complete the deal, which will compound any problems. BMY equity investors seemed to agree with our take as the stock price fell immediately on the news, dropping from $52 to $44.


As if January was not busy enough for pharmaceuticals, Eli Lilly (LLY) announced it would acquire Loxo Oncology for $8 billion. This comes after long focusing its efforts internally through R&D. LLY recently shed its animal health unit (Elanco in September 2018). The Loxo acquisition marks a major shift in strategy for LLY as it joins peers in scooping up smaller companies – whose primary asset is intellectual property of unproven drugs. The industry has been busy scooping up drugs through business acquisition, and as of lately, it seems many acquirors have charged off the acquired assets (AbbVie as example). Unlike BMY, at least LLY equity investors were lukewarm and the share price did not budge. The $8 billion will be easier to digest than what BMY is doing.


It’s tough out there, but using debt to acquire unproven or troubled drug portfolios is not prudent.


12/2018 Market Commentary


Like months past, December had a lot of news around Tesla, Musk, and sister companies. Here are some of the key items that caught our attention:


In case you were living under a rock or just returned from an off-the-grid vacation some place nice, stocks were down in December. What a month. We did say at the beginning of the year that counting on a repeat of 2017’s strong stock market performance was not a good bet. Our caution looked off for much of the year until October when the selloff began. It’s amazing what global central bank shrinking balance sheets can do to asset prices. Throw in rising interest rates, and you have a toxic mix. There are no current plans for central banks to stop the tightening, so stay tuned because the ride down will likely continue.


Much like our commentary earlier this year, we do not yet care for general price levels. We remain cautious and think you should be too. There are select opportunities though, and your team at Ballast continues to look for them.

Credit, Rates, & Commodities

Rates (10yr treasury) and major commodities continue to slide. Credit spreads have widened (risk premium increasing) substantially over the past few months. All of this has happened during what many pundits are saying is a strong economy. However, these things don’t tend to occur during a strong economy. Conversely, they tend to signal weakness. Meanwhile a portion of the interest rate curve has inverted, and an inverted curve commonly signals an imminent recession. Stay tuned.

Hindsight Capital

This piece is entertaining and provides a good perspective. Maybe someday Ballast will have the abilities to launch a hedge fund, Hindsight Capital.


Everyone is doing it. AB Inbev (parent of Anheuser Busch) and Altria (parent of Marlboro) have entered the cannabis fray. The former is forming a joint venture (pun?) with Tilray, a Canadian cannabis company, to research nonalcoholic beverages. The latter paid $1.8 billion to acquired 45% of Canadian cannabis company Cronos Group. There has been interest elsewhere in the market of large consumable goods as well. All relevant industry groups appear to be gearing up for a different future in the U.S. We think that future is coming but remains, generally, not investible.

China, What's Wrong?

Chinese companies have had great success raising capital lately through IPOs. What’s alarming though is that Chinese company IPOs in the US now exceed those in the mainland. Wait! What!? What’s wrong with China?

Buyer beware. And that means you too, index investors. Your index might contain things you otherwise might not want.


We discussed Netflix previously. Basically, this company spends billions more than it earns to rapidly buy up content in order to appease its subscribers (so they don’t go somewhere else). What’s weird though is that Netflix’s top viewed programs are content owned by others (see chart in middle of page). These shows are owned by other major networks – many of which are building out their own streaming services. If their own shows are not ranking well, then what’s the return on investment for Netflix owned content, you ask? Maybe when the Federal Reserve’s balance sheet is much smaller, we’ll find out.

Absurdity finds limit?

We wrote about SoftBank and WeWork in October, highlighting the high valuation the former has placed on the latter despite the lack of earnings of the latter. It seems absurdity may have found a limit. Key capital partners to SoftBank’s Vision Fund are balking at the latest valuation and proposed investment into WeWork.

CLOs & Leveraged Loans

We have previously discussed leveraged loans and CLOs separately. They are related markets – the latter invests in the former. There has been a lot of commotion recently.

Many market participants are shedding risk in the space.  In fact, some of these groups are beholden to investor redemptions/contributions (or fund flows in industry speak). Flow has been one way for a while, and now it’s going the other way – out. Another market participant, banks, have been unloading leveraged loans to protect their balance sheet. This is causing pricing to fall and discounts to grow.

By the way, banks have been happy to oblige the lending boom to date because the fees have been so good. This is a contributing factor to how you can get risk skewed too far the wrong way. But don’t worry, everything is fine.

This loan market dislocation can present good investment opportunities. Ballast continues to monitor the situation.

07/2018 Market Commentary

Triple C Priced to Perfection

We opened a market brief on Bloomberg (no public link available; for anyone with a terminal: {NSN PCQ8R66K50Y0 <GO>}) by accident to close out the month on July 31, but it made us pause. Key lines of the brief are as follows:

  • CCC yield fell to 7.89% (lower since Sept. 22, 2014) after the steepest drop since Dec. 30, 2008.
  • CCC spreads are closed at a 4Y low of +512, the biggest decline in 10 years.
  • Morgan Stanley warned investors about ‘significant potential downside’ in CCC credits.

For starters, we don’t often find ourselves in the camp on Morgan Stanley, and yet here we are. Investors are still evidently zealous for yield. This surprises us with all the talk of bond bubble, record weakness in covenants, and zombie companies. We think there are a lot of places to not be invested at this point in the cycle and this part of the credit curve is (generally) one of them.

We think yield-starved investors continue to push capital wherever yields surface. We suspect the biggest conduits and investors to be Business Development Corporations (publicly traded small and medium enterprise lenders) and Collateralized Loan Obligations (CLO), and they are the primary enablers for this market. The former is available to and popular with retail investors, while the latter has been hot with institutional investors.

CLO's are Forever

Until they are not. Quantitative minded investors have been effective at observing historical losses of the asset class and calculating excess returns. If you are an institution looking for good relative value, this has been the place to be. With the recent resurgence in CLO interest (since the last cycle end – Great Financial Crisis), many new CLO managers have surfaced and met rising demand for their product. The problem is the CLO owner is beholden to many things out of their control, and when the market turns, liquidity goes away. It is not until then that investors will find out how good their CLO manager is – only with hindsight. And those historical losses – we’ll see if the next is the same as the last. In the meantime, sounds like the CLO market started to flash warning signs.

Tesla Tesla Tesla

A reference to the Brady Bunch or summoning Candyman? Elon Musk was summoned by a critic of Tesla, writing under the pseudonym Montana Skeptic on Seeking Alpha, and Musk silenced the critic. The analyst and an editor of Seeking Alpha both commented on the event and confirmed. Montana Skeptic, to keep his employer from public scrutiny, as well out of legal wrangling, agreed to cease writing about Tesla.

That was not it though, as a lot happened during July for Tesla. Remember, Tesla’s cash flow has been of critical focus, and many suspect the company will need to do raise capital – which Musk has strongly denied. In addition to the silencing mentioned above, we summarize the month here:

  • Tesla is thinking about building a Tesla Gigafactory in Europe. This could provide cover for capital raise…even though it is not needed…
  • Tesla is thinking about building a Tesla Gigafactory in China. This could provide cover for a capital raise…even though it is not needed…
  • There were more high profile executive departures.
  • There was distraction with sending help (ultimately determined unneeded) and equipment to the Thai cave rescue.
    • Elon Musk then, very publicly, skirmished with the rescue lead and certain divers about ego things.
    • Elon Musk disparaged at least one diver in an unacceptable way, deleted the Tweet, and publicly apologized.
  • Car sale prices increased in China.

The FANG index, comprised of the crème de la crème of tech high fliers (Facebook, Apple, Netflix, Google, Amazon, Twitter, Tesla, et al), was soaring, but it hit turbulence in late July and has plummeted to correction territory. Leading the charge lower was Netflix, Facebook, and Twitter with poorly received quarterly financial results. While the index may not be Icarus, some of the constituents may be. The result is something we recommend staying away from. We continue to strategize ways of expressing our views around these select names in ways that are productive to accounts, but these are expensive times in the tech investment world.

GDP Hits 4.1%

Where is the beef? It is one quarter, and the reading spikes on occasion. Not to mention, it is often later revised as lower. The annual reading is likely to be no different than the previous few years. While headline unemployment is giving people something to cheer about, employment slack is a huge overhang for the next few years. Wages, in real terms, have treaded water (at best) for the last decade. Inflation is not budging. Celebrate not. We are not out of this yet.

Marginal Buyer. Minsky Moment?

For several years, China-based investors were the marginal buyer in capital markets. In real estate, market valuations are viewed in terms of cap rates (or the discount rate with which to value a property given its net operating income). A lower cap rate translates to a higher value and vice versa. Rewind a few years and US investors were already taking pause at the historically low cap rates. Then, China-based investors entered, and they drove cap rates even lower. Risks were mounting at home in China, and investors were prepared to take big risks overseas. In an already highly valued (real estate) market, they became the marginal buyer and were seemingly prepared to pay anything. Fast forward to today and these China-based investors are now sellers. But who is the marginal buyer today? Will they pay even lower cap rates?

05/2018 Market Commentary

We’re keeping it short and sweet this month. Check out the key events of May’s Market below.


Italy shocked the markets when anti-establishment and far-right political parties formed a coalition government this month. Global investors feared Italy would move towards an exit from the Euro, and this set asset prices lower (Italian interest rates went up and equity prices went down). This drove safe-haven assets higher – namely, US treasury rates lower (inversely related to price). The coalition leaders later stated they are not interested in leaving the European Union. As a result, markets subsequently calmed, and prices rebounded a bit.

We highlight two lessons here. First, investment markets are volatile, regardless of asset class and geography. These daily price movements should generally be ignored. Second, Italy experiencing trouble should be of no surprise to investment professionals. The country has weak growth, expanding debt, increasing immigration burden, and governance issues –  to name a few problems. For years, there has been worry and speculation that Italy may leave the Union. Until early May, Italy could borrow for 10 years at approximately 1.80%. That changed to 2.75% by the end of May. Over that same period, the US could borrow for 10 years at 2.95% and, by the end of the month, at 2.85%.  Why could Italy borrow for less, despite major political and economic challenges? Restating our second point, investment professionals should not be surprised.


We have discussed Netflix in past newsletters with a case study and commentary. This month we were struck by Netflix’s market capitalization exceeding Disney’s for the first time. Why were we struck by this?

  • Disney generated $56.9 billion sales for the twelve months ended 3/31. Netflix $12.7 billion for the same period.
  • Disney produced $9.7 billion net income for the same period. Netflix $0.7 billion.
  • Disney free cash flow was $10.6 billion for the period. Netflix -$1.8 billion (that’s negative).
  • Disney’s price-to-earnings ratio* is 13.7x. Netflix 124x.
  • Disney pays a dividend. Netflix does not.
  • Disney assets include all that is Disney (including theme parks), ESPN, ABC, joint venture HULU, Starwars, Pixar, and many more. Netflix includes House of Cards, Orange is the New Black, and many others that Ballast is not familiar with.

If forced to choose between Disney and Netflix, Disney is hands-down who we would chose to own on a long-term basis. We say there is no contest and think investors should be very cautious with Netflix.

*A way of thinking about richness of price, how much you pay relative to what the underlying earns

Subprime Auto

Although subprime auto lending is not set up to be as ruinous as subprime housing was in the financial crisis a decade ago, we do suspect losses will get worse and will be bad for some non-discerning investors. Following the financial crisis, this sector of lending became a boom area and shady practices crept in. Credit standards fell, and loan terms became more generous. Now, cracks continue to show in the subprime auto market, while at the same time lending conditions continue to be favorable overall.

According to a Bloomberg piece, borrower delinquency rate has hit the highest level since 1996. The article says that new credit flowing to subprime is declining, but to overall auto, it is increasing. Moreover, the auto asset-backed-security market is setting record pace – meaning high loan volume – and subprime loans continue to represent a growing percentage of overall securitizations. A separate Bloomberg piece (no link available), says that the “riskiest subprime-auto bonds reach record low risk premium”. More to the point, the second Bloomberg piece states

“B-rated tranche came in with spread of 3.25 percentage points above the benchmark and a yield of 6.12 percent, which is 10 basis points tighter than what the company got on a similar sale in January.”

This means investors are willing to accept a lower rate of return for what (we think) is increasing risk.

There are a few primary points we highlight here. 1) Subprime lending may find trouble once again. The practices of problems past find new ways forward. Lessons may be learned, but memories are short. 2) Like the period following the financial crisis, we think there will be good investment opportunities for the discerning and patient investor. Ballast is watching. 3) For anyone in the market for a car, a little patience may get you a better deal. Cars coming off lease have been driving values lower. Look for popular lease models of two and three years ago for the best deals. However, turmoil elsewhere in the market could drive prices lower altogether. Time will tell.


Like Netflix, we have discussed Tesla in the past with a case study and commentary. A couple things happened in May that seem to reiterate past points: Tesla Model 3 received poor reviews – here and here – but Consumer Reports (latter link) changes its review to a recommendation after Tesla fixed the brakes. Another senior executive is said to have left Tesla as well.

03/2018 Market Commentary

So much happened during March, so bear with us as we walk you through it all. We’ve got a new Market Commentary format for you too this month. While we hope it is easier for you to find those topics of interest, don’t be shy. It’s all important as you charge into 2018.

Market Correction

Recovery complete: Nasdaq hits new record. Well, that was easy.

March 2018 Nasdaq

Warren Buffett / Berkshire Hathaway

The much-anticipated Berkshire Hathaway 2017 shareholder letter from Warren Buffett was published this month. The following bullet points are key highlights by Ballast.

  • Key qualities we seek […] a sensible purchase price. That last requirement proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an all-time high. Indeed, price seemed almost irrelevant to an army of optimistic purchasers.
  • Once a CEO hungers for a deal, he or she will never lack for forecasts that justify the purchase. Subordinates will be cheering, envisioning enlarged domains and the compensation levels that typically increase with corporate size. Investment bankers, smelling huge fees, will be applauding as well. (Don’t ask the barber whether you need a haircut.) If historical performance of the target falls short of validating its acquisition, large “synergies” will be forecast. Spreadsheets never disappoint.
  • The ample availability of extraordinarily cheap debt in 2017 further fueled purchase activity. After all, even a high-priced deal will usually boost per-share earnings if it is debt-financed. At Berkshire, in contrast, we evaluate acquisition on an all-equity basis, knowing that our taste for overall debt is very low and that to assign a large portion of our debt to any individual business would generally be fallacious (leaving aside certain exceptions, such as debt dedicated to Clayton’s lending portfolio or to the fixed-asset commitments at our regulated utilities). We also never factor in, nor do we often find, synergies.
  • Our aversion to leverage has dampened our returns over the years. But Charlie and I sleep well. Both of us believe it is insane to risk what you have and need in order to obtain what you don’t need. We held this view 50 years ago when we each ran an investment partnership, funded by a few friends and relatives who trusted us. We also hold it today after a million or so “partners” have joined us at Berkshire.

This last point should settle in. Leverage can help you get somewhere, but reducing leverage will allow you to stay there.

If you heed Mr. Buffett and have been an excited equity investor in the recent year, we would encourage you re-read the first bullet point above. The other points provide excellent expert perspective of general activities we are seeing in the market place.


We have commented on Netflix in previous newsletters. An analyst at UBS upgraded Netflix recommendation, and the stock price and company market capitalization set new records. Speculators may play, but the gravitational pull of cash flows and earnings will eventually have its way.


Speaking of speculators… Tesla has its work cut out for it.

General Electric

We discussed GE in our January newsletter. In it, we explained an adverse scenario that we had heard from a hedge fund manager. We had disagreed on it and sought comment from GE, as well as the hedge fund, for clarification. The hedge fund never responded, but GE Investor Relations talked to us about recent insurance charges in the Capital unit, as well as the long-term service agreements, the importance of credit ratings to sales, and company commitment to deleverage.

A GE related headline hit the press in March. General Electric – industrial conglomerate and manufacturer of electricity generation turbines, jet engines, healthcare equipment, oil & gas equipment, and a lot more – market capitalization fell below that of each of the FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google) for the first time. What GE produces is the backbone of the economy.

We continue to monitor GE with interest.

Dollar Tree

The economy is strong, and inflation is about to rise – or so popular market narrative goes. However, Dollar Tree (the owner of chains, Dollar Tree and Family Dollar) shares fell as much as 15% on March 7 due to a weak outlook that was provided during the company’s latest reporting to investors. The company is not exactly the bellwether for the stock market, but how can things be looking down for Dollar Tree while inflation, wage, and earnings expectations continue to rise and drive the narrative? We wonder. To us, this would suggest one of two scenarios: 1) that low-wage earners are doing well and upgrading consumption or 2) that they are not doing well and tightening belts. Gas prices and rent (key expenses for most households) have increased in the past year (CPI was +2.2% in February), while average hourly wages increased 2.5% y/y.

Dollar tree

Oil Market

Many seem to have an opinion on which direction oil is going. In fact, last summer, Ballast said, “our opinion is for status quo or lower near-term” but that was back when oil (WTI) was $50. Now it is $65. While we feel somewhat the same today, we’ve seen a few industry leaders make some points that are difficult to ignore.

Mark Papa, an industry titan and former CEO of EOG Resources, was recently recruited out of retirement to run a new company formed by private equity to acquire shale assets out of the energy distress in 2016. We think he is worth listening to. Mr. Papa has made waves with public comments about the promise of the shale revolution. His point is that it’s not as promising as many think – the low hanging fruit has been picked, and it gets worse from here. The article linked above highlights, among Papa’s points, the best drilling locations in both North Dakota and South Texas have been tapped, rivals are being too optimistic, operational challenges abound, and high returns now demanded by investors are leading to squeeze. Papa expects the US will not fulfill oil production projections. The bottom line, according to this thinking, is that oil prices are set to go higher – and soon. If correct, it seems like significantly higher oil prices would choke US economic growth prospects.

Cigna & Express Scripts

More mind-bending activities in the health care markets… In December, CVS announced it would acquire Aetna, a major health insurer. This March, Cigna, another major health insurer, agreed to acquire Express Scripts, a pharmacy benefit manager. We won’t layout the background of each here, only that our immediate reaction to the news was, “huh!?” and our reaction was matched by the equity markets. Cigna’s stock promptly fell in price. The price began the month at $195, and it has settled to around $167 now. In fact, Cigna’s stock price reached its apex of $225 in late January 2018. The Express Scripts acquisition will represent a major leveraging event, and we see no clear value in the combination. To the contrary, we suspect there will be value destruction. We shall steer our clients clear of this heap.


Buying things that “might be” is not generally a good policy. It’s especially not a good policy at high prices. A few years ago, there was an “arms race” of sorts for companies to buy potential block buster drugs in the pharmaceuticals industry before peers did. At the beginning of 2018, that arms race seemed to have kicked off again with big acquisitions by Celgene (Juno and Impact) and others as risks have mounted in existing drug portfolios. These risks have become pronounced with big headlines of drugs failing in trials or being pulled. Biogen and Abbvie took their multiple sclerosis drug off the market after patients were suffering severe complications from the treatment. Not long after, Abbvie announced that a key drug in its pipeline had disappointed in drug trials. Both Biogen and Abbvie stock prices have suffered greatly in March. Several other pharmaceutical companies have too. We only highlight this here as risks lurk, and in our opinion, many investors have not been paying attention.

Insurance & Reinsurance

Continuing previous comment pieces on the insurance and reinsurance market, here we point out the AXA acquisition of XL Group for $15.3 billion. Now, Aspen Insurance Holdings may be placing a “for sale” sign up. The reinsurance market is clearly consolidating, but there is no evidence yet that capital is leaving. This means high competition and status quo of undesirable profitability.