The news out of Puerto Rico was somewhat quiet this quarter. Puerto Rico’s new governor, Ricky Rossello, took office on January 1, 2017. He has stated his opposition to default and his goal is to work with bondholders on a restructuring, aiming for a settlement out of court. That tone is an encouraging change from the prior administration’s and hopefully it will be followed with action. The seven members of the oversight board who are tasked with overseeing Puerto Rico’s restructuring hope to certify a fiscal turnaround plan in the next month or two. Their work in the first half of the year will be critical and it will likely provide some clues as to how successful their efforts will ultimately be.
In December Ambac announced that Claude LeBlanc would replace Nader Tavakoli as CEO effective January 1, 2017. Mr. LeBlanc lead the successful and now largely completed restructuring of Syncora, another financial guarantor with legacy issues dating to the financial crisis. By all accounts Mr. LeBlanc did excellent work and he is well regarded by his colleagues, peers, and regulators. Although Mr. Tavakoli had less than a year as the full-time CEO of Ambac, I might speculate that the board saw in Mr. LeBlanc an opportunity that was too good to pass up.
AGO continued its efforts to put its excess capital to work via acquisitions, buybacks, and dividends. Over the past few years the company has acquired several insurance portfolios at very attractive prices. It has also continued to reshape the balance sheet as policies roll off, value accretes to the equity, and excess capital is deployed.
In late November AGO’s special request for a $300 million share repurchase, funded by the operating insurance company, was approved by the regulator. This is a continuation of AGO’s intelligent policy regarding dividends and share repurchases and I believe the company is likely to be able to continue to repurchase 5-10% of its outstanding shares per year. Since the inception of its current capital management strategy in 2013, AGO has repurchased approximately 34% of its outstanding shares at an average price of roughly $24.50 per share. Operating book value – a decent if imperfect proxy for current liquidation value – increased over that period from the low $30s to nearly $50 per share today, and all of AGO’s repurchases were made at a meaningful discount to book value and to my estimate of intrinsic value. With the stock price recently near $40 per share and the balance sheet still awash in excess capital, this is an excellent example of the “good” kind of share repurchases – the kind that are made at a discount and leave remaining shareholders much better off.
We purchased our initial stake in AGO in January 2013. We added shares as we took in capital and we held on through some teeth-grinding frustration and several bouts of market-driven volatility. (I still remember the Sunday in June 2015 when now ex-Governor Alejandro Garcia Padilla said “the debt is not payable.” The next morning the stock fell about 25% and to compound the misery Julian Robertson went on CNBC and said he was short AGO.) But we hung on because there was real progress being made in the business and because there was a large gap between the market price and our estimate of value. I checked, re-checked, and triple-checked our assumptions, but I could not find a compelling reason to reverse course.
That patience was rewarded this year. The total return on the AGO investment – which will, of course, not correspond to all individual partners’ actual returns from this security – was more than 160%, or just over 27% compounded annually. From the beginning of 2014 through the end of 2016, the return total return was 69.1%, or 19.1% per year. To pick two other arbitrary but illustrative points, the return from the approximate bottom of the Puerto Rico crisis (June 30, 2015) or the 1Q16 market turmoil (January 31, 2016), the total return was 62% in both cases. Again, the specific return earned on your dollar of capital as a partner will vary, but I want to highlight these illustrative returns to emphasize the importance of patience. An attractive return exceeding 19% compounded over several years could have been squandered at numerous points had we succumbed to the drumbeat of negative news, the volatility of the market price, or any other distractions. As always, the balance of patience, analysis and opportunism was paramount.
 Operating book value is GAAP book value adjusted to eliminate the effect of consolidating VIEs, the non-credit impairment and unrealized gains/losses on credit derivatives, the fair value of gains/losses on the company’s own credit instruments, and unrealized investment gains/losses, along with associated tax effects. Source: SEC filings.
 Source: FactSet. Data presented solely as an example of what certain partners received over certain periods. Returns include dividends.
The above commentary is excerpted from a letter of Anabatic Investment Partners LLC. The fund’s Managing Principal and Portfolio Manager is Philip C. Ordway. Please note that the complete text of the disclaimer included with the fund’s quarterly letter is also reproduced below.
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