Sahm Adrangi and Kerrisdale Capital — Top Equity Investment for 2014

By Travis Johnson, Stock Gumshoe, April 3, 2014

These are my notes and instant reactions from a presentation at the Value Investing Congress, the notes below might contain errors, paraphrases, incorrect quotes, or misinterpretations.

Kerrisdale Capital is a little bit unusual — they are a value-oriented investment manager, but they also publish pretty heavily, including on their own free email distribution list and twitter and on sites like Seeking Alpha.

And today they’re presenting a favorite short idea, and they say they were among the first firms to publish their shorts and were early on the US-listed Chinese frauds.

Interestingly, they were originally LONG this company, and it was their biggest long position in 2009 and 2010. Now the stock has gone up more than 15X and has a $2 billion market cap, PE of 26, huge multiple of tangible book, has lots of coverage and is overexposed.

And this is a bit of a coincidence, because I also mentioned this stock this morning — his big short is BOFI Holdings (BOFI), parent of Bank of Internet.

This is a branchless online bank, they get assets by offering above-average interest rates and he says it’s “one of the most expensive stocks in the United States”. It has earned investors almost 1,600% and trades at 4X tangible book, hugely higher than banking peers.

And they think the business model is not that great — their net interest margin is not likely to be sustainable. There is too much competition, other banks can and do offer higher interest rates, and he thinks they have one of the largest negative interest gaps (their costs will climb when interest rates rise).

There will be pressure on both assets and liabilities. Yield on assets has been inflated by their timely investment in distressed mortgage bonds five years ago. As those roll off, their yield declines.

And their loan book has been focused on jumbo mortgages — a good sector recently, but there’s more competition now and you’ll see either credit quality decline or yields decline. Their loan loss provisions are thin and they’re taking more credit risk than investors think.

Negative interest rate gaps means that their deposits will reprice upward significantly faster than they can roll their assets into higher earning investments, which will squeeze their earnings. The average bank has securities yields of 2-2.5%, BOFI’s are at 4.74%, which seems very unsustainable and the decline ...

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