How the Crypto-FTX-Fraud Could be Masking Epic Capital Misallocation

Accounting Tools states that cash flow to stockholders is the amount of money a firm pays its equity owners. They explain that “Investors routinely compare the cash flow to stockholders to the total amount of cash flow generated by a business…” In other words: how much of the company’s free cash flow are investors getting?

Pretty simple, right? This piece suggests otherwise.

Understanding the conversion of income statement profits to operating cash flow and the uses of cash for capital spending is a basic jumping-off point for securities analysis. Suffice it to say, one could suggest the work done on this front has deteriorated sharply since the bubble took flight in 2017.

With markets down -18% this year, investors are feverish to buy the leaders of the last bull-market mania. Many seem convinced that we are just a Fed pivot away from another low-quality rally. We think current investor preference could be even more costly than the fallout from the collapsing promotional bubble stocks of 2020.

Could Crime in Crypto be Distracting Investors from Bigger Issues?

Crypto, FTX, and Bankman Fried are clogging the news. Reports suggest $8bn was swindled, and the fraud is being compared to Enron. We feel bad for those who were conned and are not here to minimize their losses.

Yet this was not an Enron. Many crypto folks didn’t want regulation. That was often a big part of the pitch. First they fought the Trump Administration’s attempt to regulate the industry. Then the crypto-crowd lobbied the Biden Administration to take a “light-touch regulatory approach” while advocating for “…the development and implementation of a U.S. central bank-issued digital currency (“CBDC”).”

Careful what you wish for.

Not sure why there’s so much surprise about FTX or other crypto frauds. We were told that tokens were not securities or even money. Many of the rules crypto fans didn’t want were put in place after the 1929 crash. Crypto advocates, please read our end note before ripping our heads off.**

Unpopular view: why should regulators get involved? People threw their money into an unregulated private exchange with offshore operations to buy unregulated tokens. These things had no operating activities, no cash flow from assets, no property plants or equipment, and generated aggregate total cash flows of zero.

Tokens remember? Not securities. Why are taxpayers funding investigations into this mess?

In our view, regulators and actual investors have much bigger items to contemplate.

As the FTX saga unfolds, there are a swath of stocks that investors appear to have an almost Pavlovian desire to buy because they are “down.” A lower price for a low-quality asset with poor growth prospects and negative cash flows does not a good investment, make. We proved this with our rips on Snapchat and Carvana Investor Relations. Both were “lower” when we wrote them up and promptly plunged even lower.

We fear the next shoe may be dropping in equity markets, and it is a much bigger issue than FTX, in our opinion.

YOU ARE NOW READING BASIC MEMBER LEVEL CONTENT

How to Calculate Net Capital Spending

While investor attention is focused on the FTX fiasco, are the true “generals” of the Ponzi cycle in the early phases of collapse? These “Ponzi generals” did nothing wrong. They are all GAAP compliant. But that does not mean their past capital allocation policies may not be wreckage waiting in the wings.

Look at Salesforce below.

[i] This is a term of art – we are NOT implying ANY of the companies we highlight in this paper of doing anything even remotely criminal.  Quite the contrary – our ability to compile this list of the “Biggest Burners” is from GAAP compliant financials publicly available to anyone.

[ii]  See note 1 immediately above – we are NOT implicating fraud of any kind

As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for a simple, concentrated, low turnover, and hard-hitting GARP investing strategy, we would like to talk with you.  Similarly, if you are looking for a model portfolio of the most proven and durable dividend payers that is simple to implement, please let us know.  KCR also offers a wide range of easy-to-use but sophisticated tools like our Equity Duration product, which allows you to estimate a given portfolio’s interest rate and inflation risk. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.

Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.

  1. As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you.  KCR also offers a wide range of easy-to-use but sophisticated tools.  Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
  2. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.

Disclaimer

The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seek independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction.

Nothing herein shall limit or restrict the right of affiliates of Kailash Capital, LLC to perform investment management or advisory services for any other persons or entities. Furthermore, nothing herein shall limit or restrict affiliates of Kailash Capital, LLC from buying, selling, or trading securities or other investments for their own accounts or for the accounts of their clients. Affiliates of Kailash Capital, LLC may at any time have, acquire, increase, decrease or dispose of the securities or other investments referenced in this publication. Kailash Capital, LLC shall have no obligation to recommend securities or investments in this publication as a result of its affiliates’ investment activities for their own accounts or for the accounts of their clients.

© 2022 Kailash Capital, LLC – All rights reserved.

December 30, 2022 |

Categories: White Papers

December 30, 2022

Categories: White Papers

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