Trump administration unveils plan to revamp the housing market; Doug Kass' case for Amazon

By Whitney Tilson

Friday, September 6, 2019
A A

1) Eleven years ago today, with mortgage giants Fannie Mae (FNMA) and Freddie Mac (FMCC) teetering on the edge of bankruptcy amidst the collapse of the housing market, the federal government put them into conservatorship. The government-sponsored entities (“GSEs”) that underpin the debt of the U.S. housing market have remained wards of the state ever since.

The GSEs eventually recovered and are now thriving, together earning more than $20 billion in annual profits. The government has been taking all of it since 2012 via a “net worth sweep,” a blatantly illegal act still being challenged in court to this day. In total, the government has collected more than $300 billion, far more than the $191 billion it lent to the GSEs – plus it still owns warrants for 79.9% of their shares outstanding.

The Trump administration has made it clear since its first days that it wishes to recapitalize and release the GSEs from conservatorship. To that end, yesterday after the close it released its plan to recapitalize and release from conservatorship the two. Here is the Treasury’s press release and report, the U.S. Department of Housing and Urban Development’s report, and a Washington Post article about it: Trump administration unveils plan to revamp the housing market. Excerpt:

The Trump administration released a sweeping plan Thursday that could remake the U.S. housing market, starting with ending more than a decade of government control of two massive companies, Fannie Mae and Freddie Mac, that back half of the nation’s mortgages.

The long-awaited plan from the Treasury Department features nearly 50 proposals, including many technical changes to financial regulations, and is aimed at shrinking the government’s role in the housing market. The cornerstone of the plan would resolve the fates of the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, which 11 years ago this week were put into government conservatorship during the global financial crisis.

My quick take is that I like what I’ve read so far, though the devil will be in the details about what can be done administratively (i.e., without Congressional action, which is unlikely), how much capital the GSEs will have to raise, how they will raise it, how much the government will charge for its backstop, etc.

Their stocks are down today, likely due to the plan’s lack of specificity, and perhaps to concerns that regulators will force the GSEs to raise large amounts of capital. But I have a different take…

Not only does the government own 79.9% of the equity, but it also wants the GSEs to be able to raise a lot of capital so that taxpayers will never have to bail them out again. Both factors give the government a strong incentive to act in a way that leads to a higher share price.

I continue to believe that the securities of the two GSEs represent incredibly intriguing mispriced options…

For some great background on the history of the GSEs, why they nearly went under, and what should be done about them, I highly recommend this outstanding 2014 presentation by Bill Ackman of hedge fund Pershing Square, which continues to own a large position in their stocks.

2) My friend Doug Kass of Seabreeze Partners gave me permission to share this article on Amazon (AMZN), which I agree with wholeheartedly, that he posted on Tuesday behind the paywall at Real Money Pro:

The Case for Amazon 

“If a window of opportunity appears, don’t pull down the shades.”
– Tom Peters

Today RBC raised its price target on Amazon to $2600. (The shares are +$19 in a very poor tape this morning).

Amazon is now my largest individual equity long. (I have been buying back the shares on weakness after selling most of my core position at around $1900 weeks ago).

Here is a summary of my deep dive on Amazon back months ago in “Amazon at $3000? How About $5000?”

In the annals of U.S. corporate history there is no company that has as large and lengthy a runway of opportunity as Amazon.com.

It is that prism of opportunity that supports my strong belief that Amazon’s earnings growth will far exceed consensus expectations in the 2019-2022 period.

Here are the keys to my increasingly bullish case:

  1. Amazon’s first-mover advantage is now impenetrable; the company no longer can be caught by its competitors.
  2. Amazon’s broad product offerings and technological advantages no longer can be duplicated.
  3. Nor is Amazon likely to be caught by regulators. Indeed, the existential threat of more regulation and the possible imposition of growth constraints seem to be sharply diminished probabilities unless a progressive Democratic aspirant captures the White House – an increasingly unlikely event. (See my prior discussion of this.)
  4. On the wings of a nearly zero cost of capital Amazon has expended enormous sums of capital to produce the massive and insurmountable competitive advantage that exists today. That “kindness of strangers” in such scale likely will never be duplicated again by a competing business entity, thus placing Amazon light years ahead of its competition. Indeed, in this marathon of disruptive growth (a marathon approximates 26.2 miles), Amazon is at least 20 miles ahead of its closest competitor.
  5. Based on my company analysis, Amazon is about two years away from “hockey stick” earnings-per-share (EPS) growth that will far exceed consensus expectations. The source of my profit optimism and above-consensus growth projections are several fold, but are keyed on an expansion in operating leverage and profit margins produced by a lower rate of growth in expenses and higher top-line results. The latter will be aided by continued above-expected core retail sales gains and the anticipated success in the company’s high-margin advertising initiative as well as other emerging businesses.
  6. Based on our EPS models and our more optimistic assumptions of top- and bottom- line growth, I anticipated that EPS results for 2019, 2020 and 2021 will exceed consensus forecasts by more than 10% in each of those years – and possibly considerably more! Also, 2021 is the year when the largest gain relative to expectations is projected. With more than one quarter of this year already in the rear-view mirror, it is not too early to consider results out two years.
  7. The shares of Amazon have not been materially embraced and exploited relative to other peer stocks by institutional investors. As an example (and anecdotally), in my Bull/Bear debate with Tobias Lefkovich at Citigroup on Monday, the audience of large institutional investors was asked how many held the shares of Amazon. Only five out of about 30 investors answered the question affirmatively. In terms of the other three FANG constituents, Amazon has the lowest component of institutional ownership:

Institutional Ownership as a Percentage of Shares Outstanding
Facebook 75%
Amazon 57%
Netflix 77%
Google 81%

  1. In emphasizing Amazon’s retail, emerging business and operating/financial strengths, I have not even discussed AWS cloud services, which I will save for a further discussion. It’s the icing on the cake.

Background

After a series of forays on the short side (some profitable, some unprofitable) over the last few years, I purchased Amazon in late December and added the stock to my Best Ideas List as a long on Dec. 26, 2018, at $1,383. The shares are currently trading at about $1,820. I cited:

“Amazon’s business franchise is secure and getting stronger. The competitive threats seem surmountable, and its market share appears to have a widening moat. The company’s shares have also already materially discounted a modest threat of heightened regulation, which no longer seems as very threatening in any case.”
– Kass Diary, “The Case For Amazon”

At that time, the broad markets were in disarray, there were concerns about the company’s previous reporting quarter and the divorce of CEO Jeff Bezos raised vague questions about company control.

Bottom Line

With the risk of the company’s growth expansion plans no longer in jeopardy, Amazon’s competitive position is firming and its business moat has deepened. Its first-mover advantage and lead has multiplied over time and the company’s competitive reach is not likely to ever be challenged.

It is now likely that a “hockey stick” in EPS results will gather speed over the next three years and that the company will produce sales and profit growth that substantially exceed investors’ expectations.

I expect that Amazon, in the fullness of time, will become the first $2.5 trillion company.

Sometimes the best investment opportunities lie right in front of us, and Amazon might be the best example of this phenomenon today.

Thanks for sharing your excellent analysis, Doug!

Best regards,

Whitney

Whitney Tilson

Get Whitney Tilson's Empire Financial Daily delivered straight to your inbox.

About Whitney Tilson

Prior to creating Empire Financial Research, Whitney Tilson founded and ran Kase Capital Management, which managed three value-oriented hedge funds and two mutual funds. Starting out of his bedroom with only $1 million, Tilson grew assets under management to nearly $200 million.

Tilson graduated magna cum laude from Harvard College with a bachelor's degree in government in 1989. After college, he helped Wendy Kopp launch Teach for America and then spent two years as a consultant at the Boston Consulting Group. He earned his MBA from Harvard Business School in 1994, where he graduated in the top 5% of his class and was named a Baker Scholar.

Click here for the full bio