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.


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.

10/2017 Market Commentary

Combining our experience and daily focus, we aim to process, distill, and comment on various activities in the market place here in the Market Commentary section. Here are some insights from October events to highlight some of the things we have worked on and thought about on behalf of our clients:


Here is a mini-case study in Celgene stock ownership. We are not currently interested in owning the Celgene stock or bond, but we think this is a topical example that highlights the perils of equity versus bond ownership.


Celgene (ticker CELG) is a global pharmaceutical company with concentrated revenues in a key drug, Revlimid. The discerning investor may dig a little bit deeper and become less excited because of ongoing lawsuits filed by competitors trying to allow for generic competition of Revlimid. In other words, if the patent is lost, then so too may the revenues and earnings be lost. In mid-October, Celgene announced it would discontinue a late stage drug trial that would have expanded treatment use of an existing, acquired drug, Otezla. This was an important pivot strategy Celgene had undertaken to diversify revenue and earnings away from the key drug and its apparent business risks. The failed trial of Otezla sent the stock price down 10% from $136 to $122. One week later, Celgene announced quarterly financial statements and revised guidance on revenues and earnings to lower numbers. This sent the stock price down another 18% from $120 to $98. We think this example highlights one of the perils of owning stock – rapid adverse price change.


Alternatively, during the same period (month of October), Celgene’s credit spread for bonds due in 2045 widened from 125bps to 150bps above equivalent treasury rate. This caused the Celgene bond price to decline approximately 4%, but the owner of the bond would continue to expect 4% of annual yield from interest payments each year until principal/par is returned at contractual maturity – so long as the company does not default. (This is unrelated to the price decline.) As we highlighted above, Celgene’s stock price fell 30% during the same period thanks to concentrated underlying business no longer performing well. Celgene does not pay dividends, so the owner does not receive compensation in the interim for holding the risk. The stock owner just hopes that the future will bring higher price. The swinging stock price hurts those that owned it and we think there may be more problems to come for Celgene. Stay tuned.



Spain has made headlines lately because a region within the country, Catalan, took its long-pursued independence campaign to vote and received majority favor. There is plenty of controversy around whether simple majority is sufficient enough to move forward, but political turmoil has resulted, and it could translate to the economy. The independence vote resulted in immediate wrangling with Spain as Catalan began dialogue with the country, which then sought to stifle further progress of independence. The Catalan government responded by declaring independence.


Why does this matter? Spain is the ‘S’ in the peripheral European countries, commonly referred to as the PIIGS (“pigs” – Portugal, Italy, Ireland, Greece, and Spain). These countries have strapped the monetary union with weak economic performance and high debt burden. Spain remains in a challenged economic position to this day, and so, splitting the country would be complicated and likely disastrous. Catalan, the northeast region of Spain that includes Barcelona and that is adjacent to France, is a large economic contributor to Spain. According to The Guardian data, Catalan represents 6.3% of Spain land area, 16% of the population, 25.6% of exports, and comparatively lower unemployment rate.


Separating Catalan creates doubt about Spain’s ability to repay debts, which in turn, reverberates to broader Europe because of the monetary union AND because the European Central Bank has backstopped sovereign debts. Doubt is all that it takes for a crisis to form, and a crisis in Spain, we think, could mean a crisis for all of Europe. We are not suggesting this will happen. We are only suggesting that it is a major risk – one amongst a growing number that make us question price/risk across markets.


The Chinese communist party met for national congress in October, an event that takes place every five years to affirm leadership of the communist party. Xi Jinping, the incumbent president, retained and consolidated power, including elimination of critical voting. The run-up to October was preceded by relative economic and financial market stability – despite major reforms in progress (that include working through some credit losses in what has become a highly leveraged financial system).


It is important to note that China, over the last two decades, has been a global economic driver as a fervent infrastructure builder and commodity consumer. We wonder what having the national congress settled – with consolidation of powers and removal of economic targets – will bring to the investment markets. In the year or two ahead we think there may be some house cleaning (so to speak) of the excesses created during China’s substantial growth period. Moreover, we wonder what this would mean for a global investing community who may have grown accustomed to a continuous growth engine in Asia.


The Teva story, which we discussed in previous newsletters, continues to play out. During October, generic competitor, Mylan NV, received FDA approval for Teva’s multiple sclerosis therapy Copaxone. Competition is expected immediately. Ultimate impact for Teva is to be determined based on the level of discounting from Mylan’s drug relative to Teva’s. Mylan’s ability to convert active users over to the competing drug will also be important. We continue to monitor Teva.

Rivals keep Amazon at bay

We have talked recently about Amazon’s impact on various industries and found this Reuters piece interesting in how certain competitors are keeping Amazon at bay by using the fine print of lease agreements. Because of all the sectors Amazon now operates in, some peers are beginning to use lease document language to block (or limit) Amazon delivery activities, as well as Whole Foods expansion, at certain locations. The Amazon story has progressed seemingly unfettered to date, and although these are small issues, we think this highlights growing challenges at the margin hereafter for Amazon. Execution is always difficult, and Amazon faces a growing number of incumbents.

Closing Note

You may see a theme throughout much of our writing lately – that we are cautious. Some would say we are negative and bearish. Be assured that we look for positive and bullish, but by virtue of our fiduciary responsibility to clients, we worry. With valuations running to high levels relative to risks (we try to highlight these risks throughout our newsletters), we continue to think added caution is warranted.

07/2017 – Market Commentary

Combining our experience and daily focus, we aim to process, distill, and comment on various activities in the market place here in the Market Commentary section. Our purpose is to get you thinking about things in order to avoid just re-presenting otherwise meaningless statistics like unemployment level, S&P 500 closing price, etc. Ballast will provide you this commentary on an ongoing basis with the intent of delivering insight and color that is not readily available through public outlets. We assume that you are familiar with common sources for latest readings of Dow or S&P closing prices and that you see the major headlines like the Federal Reserve Bank having increased or decreased the Fed Funds rate.

In our opinion, a great deal of time and energy from sell-side economists is spent addressing unemployment, ISM Index, payrolls and all the other monthly economic releases, speaking to facts without necessarily instilling wisdom. To us, this is an outcome of the age of Google – anyone now has the ability to quickly search the internet for facts and information (and now disinformation). But knowing facts and information is different than having knowledge and wisdom.

Here are some insights from July events to highlight some of the things we have worked on and thought about on behalf of our clients:

Oil Market

With oil prices in decline for most of the month of July, high-yield debt markets began to reflect trouble in energy-related credit again. The Ballast team began re-examining some of the companies/bonds from 2015-2016 to reacquaint ourselves with the energy sector. It’s still early, but we think the opportunity could re-open if WTI oil trades back below $40/barrel, a price not seen since early 2016 when the energy sector “recovered”.


There remains a variety of reasons that oil could trade lower.  First, U.S. shale oil producers continue to grow output through increased drilling and well completions (a large number of wells were drilled but uncompleted from before and during the “crisis” of 2015-2016), which are relatively cheap to turn on in the current price environment. Operations are booming again so much so that there is said to be equipment scarcity. What!? Further, OPEC (Organization of the Petroleum Exporting Countries) is struggling to maintain its output reduction quotas due to turmoil across much of the middle east, select members being exempt from the cuts (Nigeria, Iran, Libya, et al), and suspected cheating. Oil demand continues to fall short of projections, which has kept supply in excess of or matched demand, leaving oil storage facilities around the world highly utilized much more so than in recent history. Storage levels have fluctuated regionally and traders have reacted in a number of different ways, with the result being price volatility. We think these points highlight the sensitivity and vulnerability of oil at present and therefore, positively reflect the opportunities that may arise over the next year.

Energy Private Equity

EnerVest, a large energy-focused private equity group based in Houston, Texas, splashed investment headlines during July. They had the distinguished honor of having the first private equity fund of initial size greater than $1.0 billion to go bankrupt – that’s right, their investors are likely to get zero ($0.00) of their capital back. One of EnerVest’s other funds has a NAV (Net Asset Value) described as “pennies on the dollar” and yet another one of their funds is at a material discount to initial contributed capital. We are not surprised to see such news for the industry and would not be surprised to hear of more of these instances in coming years.

Amazon Retail | Financial Services

Amazon never ceases to amaze and bewilder investors. Sears announced it had reached an agreement to sell its Kenmore appliances on the online retailer. The news boosted Sears while competitors in the space – Lowe’s, Home Depot, et al – saw their stock prices fall by 4% or more. This goes back to our thoughts on Amazon from June Market Commentary. While we think the agreement may help Sears at the margin, we remain unconvinced of the near-term implications for Lowe’s, Home Depot, et al.


Amazon hasn’t stopped making headlines there, though. In fact, there is nothing this company seemingly cannot disrupt. The latest news here is that Visa, Mastercard, Paypal, et al face long-term disruption from Amazon. Although the news did not seem to move stock prices adversely, we think the article commentary was another example of analyst over-reaction. Otherwise, we hope Amazon does not start an investment advisory business. On that note, robo-advising is on the rise and is likely to be a topic of a future Ballast piece. Stay tuned.


Under pressure from both Chinese and U.S. governments, there has been more news of Chinese companies slowing acquisitiveness. We think a significant portion of today’s market valuations reflect takeover premiums – that is that the potential for company to be acquired is reflected in its price. Since Chinese companies have been a large participant in acquisitions in recent years, we think the absence of Chinese buyers will slow acquisitions and cause the equity markets to move sideways until another catalyst emerges for an up or down movement.


Greece has been in financial trouble for a number of years. The EU, rightly or wrongly, has held Greece financial prisoner. The country has been forced to implement strict measures to shore-up large and long-running deficits in order to stabilize outstanding debts of the country. Further, Greece has been in and out of recession for at least half a decade, and needless to say, the bond issuance from the country has been both infrequent and high-yield. The country is at a level comparable to emerging market countries.


Greece was able to issue €3.0 billion five-year bonds to the market at 4.625% yield with the deal two-times oversubscribed, which means there was twice as much interest in the deal than bonds available. While it’s not a century bond like Argentina issued in June, we think the Greek issuance echoes our thoughts on the Argentina bond we commented on in the June Market Commentary piece. Investors appear to be yield-hungry regardless of risk.


AstraZeneca (AZN), a global pharmaceutical company, reported  disappointing research of a key trial drug in the company’s pipeline. The drug is an immunotherapy for treating lung cancer, and it was expected to be a blockbuster (high revenue and earnings potential) and a primary treatment for lung cancer patients. On the news, AZN stock promptly traded 16% lower. This made sense to us given the significance the drug represented to future earnings.


Thinking this would be an opportunity for the credit side, we looked to the bonds for more attractive value. What we found did not make sense – bond spreads remained at recent tights (low spread means high price) and so the bonds remain richly valued. Having followed the company for a few years, we think the announcement means more than has been reflected in the credit spreads. Front in our mind is that Pfizer (PFE) made an offer to acquire AZN three years ago for £55/share and AZN “successfully” resisted the takeover, causing PFE to walk away. As of this writing AZN shares trade at £42. We’ve seen this type of thing several times in the last five years and cannot understand the governance at some of these pharmaceutical companies.


Underscoring our caution with AZN valuation, the CEO was rumored to be a top candidate to take the vacant seat at Teva, another pharmaceutical company – and a story we have followed. The AZN news may be just the thing for its CEO to make the switch. This would open AZN to strategic uncertainty, and it confirms the execution of strategy at AZN is not what was otherwise anticipated, as well as the fact that the Pfizer deal was a good deal. The only thing we can think of is that creditors believe a takeover is now back in play (which would come at the cost of shareholders’ lost opportunity three years prior), and so credit spreads may be reflecting this. A takeover is uncertain and the acquirer could be of weaker credit quality, so tight spreads are of little interest to us here.


We think this was a rare instance where the equity analysts and market reacted correctly and the credit analysts and market did not. We passed on AZN for now as the opportunity has not materialized as we expected.

The Ballast investment team continuously monitors events like those outlined above, as well as the opportunities that arise from them.