market folly

Whitney Tilson, hedge fund manager of T2 Partners recently commented on the latest round of SEC 13F filings and how people tend to misread them. We thought this was an excellent time to continue our impromptu lessons on 13F filings that we started yesterday. Today's topics? Discerning net exposures in positions and distinguishing when ownership of common stock is not necessarily a long position. The following is printed with permission from Mr. Tilson regarding message board participants improperly reading his firm's 13F:

"It says a lot about who owns InterOil when folks on the company’s message boards are saying we’ve gone long the stock based on our 13-F. HA! This is a very large bearish bet for us. A lot of people make this mistake when reading 13-Fs: managers often own puts (which are also disclosed in the 13-F) or are short a stock (which isn’t disclosed) and then own a small offsetting long position to make it easy to trade around it.

In our case, our 13F shows that as of 6/30, we owned 1,623 put contracts (representing 162,300 shares of stock) on IOC and, in addition, were long a mere 10,400 shares. Puts can be very hard to trade, so we just bought more puts than we wanted and offset the extra amount by buying some stock, resulting in the desired net exposure. Then, if we want to increase or decrease our bearish bet, we can simply buy or sell the stock."

This just reinforces the need for investors to *read* 13F filings carefully. In particular, make sure to glance at the right-hand columns on the filing to distinguish whether a position is a stock option (put or call) rather than just common stock. Just yesterday, Bloomberg omitted options positions from an article on 13F analysis. And today, we see that message board readers have either overlooked the options portion of T2's filing or misinterpreted their common stock position.

T2's actions of buying puts and then buying a small slice of common stock illustrate an important example of liquidity and having the ability to trade around a position. This becomes even more important in stocks that are heavily shorted and can swing wildly with volatility. So if a hedge fund owns multiple securities of the same company, you have to assess the values of each individual security to ultimately determine if it is a bullish or bearish wager. And in T2 Partners' case, they own way more puts than common stock, resulting in an obvious bearish bet.

Tilson also updated us on T2 Partners' short position in IOC. We've detailed this stake numerous times in the past as it's rare you see fund managers talk openly about their short positions. As such, we've taken the opportunity below to highlight Tilson's recent thoughts on InterOil:

"We added to our bearish bet (yesterday), as InterOil reported Q2 earnings yesterday that reinforced our investment thesis. The earnings and EBITDA (driven by the refinery operation) are irrelevant for a company that has a $2.9 BILLION (not a typo) market cap; what really matters if whether there is, in fact, the Sierra Madre of oil and gas in the areas being explored by InterOil and, if so, whether they have the cash to find it, develop it commercially, etc.

Re: the former, there continues to be no proven or even probable reserves – just more hype and gibberish like this from the earnings release:

The Antelope 2 horizontal well confirmed a higher condensate-to-natural gas ratio of 20.4 barrels per million cubic feet of natural gas, 27% higher than observed at the top of the reservoir. The horizontal well also demonstrated dolomitization and higher porosity deeper in the reservoir than previously modeled.

And re. the cash, this company is going to hit the wall soon. Over the past four quarters, net income is -$1.3 million and free cash flow is -$181.9 million (cash from operating activities minus “expenditure on oil and gas properties” and “expenditure on plant and equipment, net of disposals”, broken down as follows:

Q3 09: -$48.6 million
Q4 09: -$40.7 million
Q1 10: -$28.5 million
Q2 10: -$64.1 million
TOTAL: $181.9 million)

So with no profits to fund such massively negative cash flows, how is InterOil doing it? Answer #1: Burning through cash (unrestricted cash has declined from $96.4 million a year ago to $31.7 million today). Answer #2: Taking on debt (the working capital facility – short-term debt – is up from $4.0 million a year ago to $57.7 million today, partly offset by a $9 million decline in a secured loan). Answer #3: Issuing stock and conversion of debt ($12.8 million over the past 12 months), resulting in the diluted share count rising 16.1%. Answer #4: Misc. other stuff (“Proceeds from IPI cash calls” ($15.2M in the first two quarters of 2010), “Proceeds received on sale of exploration assets” ($13.9M in Q1), and “Proceeds from Petromin for Elk and Antelope field development” ($5M over the past 12 months).

To summarize, InterOil has only $31.7 million in unrestricted cash as of June 30th and they’re burning an average of $45.5 million of cash each quarter. No wonder the company entered a short-term $25 million credit facility last week on distressed terms: 10% interest (in this environment!), secured by a 2.5% stake in InterOil’s Elk and Antelope fields. Note that the provider of financing was a very dicey outfit, Clarion Finanz and known stock promoter Carlo Civelli – see this post."

In the past, we've also highlighted some of T2's other short positions for those interested. And for more on interpreting SEC filings correctly, head to our post from yesterday regarding Eric Mindich's hedge fund Eton Park and lessons regarding 13F filings.