Motley Fool Hidden Gems Investing - "This one's gonna leave a mark."

Episode Date: March 9, 2023

(0:21) Jim Gillies discusses: - Why shares of SVB Financial Group are plunging more than 45% - The reasons he's a fan of AerCap Holdings' secondary offering (15:24) Ricky Mulvey talks with investigative reporter Marshall Zelinger about Xcel Energy and the fundamentals of being a monopoly. Companies discussed: SIVB, AER, XEL Host: Chris Hill Guests: Jim Gillies, Marshall Zelinger Producer: Ricky Mulvey Engineer: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

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Motley Fool Money starts now. I'm Chris Hale. Joining me today, our man in Canada, Motley Fool Senior Analyst Jim Gillies. Good to see you, my friend. Good to be seen, Chris. We've got two companies under the umbrella of raising capital. I think it's accurate to say you are horrified by one of these moves, and you are excited about the other. Let's start with the horror movie first. Shares of SVB Financial Group are down 45% today, as you and I are having this conversation. This is a company formerly known as Silicon Valley Bank. What is happening that is sending the stock down this much in a single day? Nothing good. Quite often, of course,

when you see a stock just get taken behind the woodshed, the first question is, is this a buying opportunity? I'm going to humbly suggest this is not a buying opportunity, and you might want to give this one some thought. I always call them Silicon Valley Bank, even though I know they did change their name, so Silicon Valley Bank. They have announced this morning, I believe it's about $1.75 billion in a stock offering, which is probably contributing to the pounding the stock is getting right now, another $500 million in preferred stock, because their balance sheet had a smoldering fuse on it for a while, and it pretty much looks like it's blown wide open. It's also sold $20 billion or so of available-for-sale securities, designated

available for sale in its portfolio. They're going to take a near $2 billion loss on that, I believe, this quarter. But the reason they're doing this, and I want to shout out, there's a great Twitter follow, Raging Capital Ventures, who had this one pretty much pegged back in January. This Twitter participant identified the biggest issue at Silicon Valley Bank isn't the loans necessarily it's making to startups and tech firms. We had free money, you know, years of zero interest rate policy, free money, Silicon Valley, you know, so any idea could get floated basically, but is rather a lot of their portfolio, the investment portfolio is held in what are called held-to-maturity mortgages. And the average yield on those

mortgages is somewhere well below 2%, it's about 1.6%, 1.7%, I believe. And so, we're going to go back to school here a little bit, Chris. The central axiom of financial theory is that interest rates, I know, I'm sorry, I'm sorry, Fools, I'm sorry, but the central axiom of modern finance, the central axiom of finance is that interest rates and asset values, and by the way, mortgages are assets if you hold them, if you're the bank, central axiom of finance and interest rates and asset values are inversely related. That means rates up, asset prices down, rates down, asset prices up. Hey, what happened in 2022, again, with interest rates? Oh, they went up.

Yeah. A little bit or a lot? A lot. Oh, yeah, yeah. Okay. So, the value of those mortgages on Silicon Valley Bank's balance sheet, again, those are the assets, so they are down a lot because interest rates are up a lot. The estimated losses on this health and maturity portfolio looks to be north of $16 billion, and as of the most recent December 22 balance sheet. Well, the problem is Silicon Valley Bank had about $12.5 billion of common equity, and about another $3.5 billion, I think, of preferred equity. The point is, if you realize or recognize these losses on this health and maturity portfolio, you wipe out the entirety of your equity position,

and we have a word for that, and that word is insolvent. Banks that are insolvent, well, the share price does a lot worse than what it's doing today, and it's not doing great things today. Before we move on, though, I … Well, I'm not done. I know, but that's why I wanted to interject. Because you said something early on that I think is important, is that while you and I are having this conversation, somewhere out there, there's more than a couple of investors who are looking at this. They are looking at this and they're saying, boy, down 45%. I mean, I don't have to put a lot into this. But something you had mentioned to me earlier today is that you said

This is going to sting them, Silicon Valley Bank, for a long time to come. For years. Yeah, this one's going to leave a mark, and it might do more than that. I don't want to be a doomsayer, the apocalypse is upon us, because worse companies have survived worse than this, but this is not good. So, they're stuck with this giant portfolio of health and maturity loans, mortgages, that basically went in at a market top. They're not going to get bailed out. There's going to be no Fed pivot. Rates are not going back to near zero. In fact, rates are continuing to go in the wrong direction for Silicon Valley Bank here. But the good news for them, the good news is the accounting

rules don't force them to market the losses on these things. Meaning, it's kind of shoring up their balance sheet. But the bad news is you can't sell any because the second you sell one, you've got to revalue all of them. So, they're stuck. And that's what today's equity sale and preferred stock sale is about. They're bolstering a balance sheet. But even if they avoid the worst case scenario, which is insolvency and bankruptcy, given that you've now got this bigger equity base, returns on equity, the ability to make money for Silicon Valley Bank, I think, is going to be impaired for a while. As you say, it's down about 45%. We haven't even talked about things Like, look, banking is often about perception and, you know, if you lose confidence in a bank,

what's your first move? If you're no longer confident in your bank, you tend to go, you know, you heard of a bank run, right? Like, people tend to say, oh, crap, let me get my money out. So, the risk here as well is that their troubles, as they kind of blossom out, kind of accelerate maybe a bit of a run on deposits. So, if your money is with them, maybe people start going, I'll take my cash back. We haven't even talked about some of the venture bets that they've met that they made with people's deposits and whatever in their capital. Of course, it's bank, so they run levered. I'm not sure what their leverage ratio is, but if you were to tell me it was 10 to 1, it wouldn't shock me. They could be risking losing some deposits. They could be

risking some of those venture bets they made with people's money. I don't know if you've looked at what's happened to tech stocks the past couple of years, it's not great. This has a non-zero potential to cascade, and cascading is not good. Even though this thing is down about 45% as we speak, I am not going anywhere near this thing for a very, very long while, probably ever. All right, then, let's move on to one that you're, as I said, you're more excited about. Aircap Holdings is doing a secondary offering. What is it about this opportunity? More than most things, I feel like there's a pretty big delta on secondary offerings. There are times where people are like, this is amazing. This is brilliant. I love this.

And there are other times where it's just a big red flag that's waving. What is it about this secondary offering from AirCap Holdings that has you excited? Well, we just had the big red flag waving with Silicon Valley Bank. So, yeah, AirCap, they're not only doing a secondary offering, they've upsized it. They were originally going to offer 18 million shares. I think they have about 250 million shares outstanding. They've upsized it to 23 million shares. And they've given the underwriters an option for another $3.5 million, $3.45 million.

AirCap is the world's largest aircraft lassoir. They work with pretty much every airline. And this is a great secondary offering, because AirCap is not receiving one red cent from this offering. Now, that sounds counterintuitive, right? They're not getting the penny. Yes, it does. Yeah. This is a happy dance event, Fools. AirCap was already the world's largest aircraft lessor in late 2021. They were always the world's biggest. Then they just supersized it and put everyone else. In a leasing business, bigger means more clout, means you can negotiate lower rates. Debt is raw material for lessors. Don't get terribly worried when you see a leveraged balance sheet for these types of companies because they've

they've got assets on the other side, in this case, those are aircraft, and they're very adept at running the aircraft through good times and then selling them above book value when they start to, you know, when some of the gloss comes off these things. It's an aircraft, so obviously, it's a little more complicated than that, but they're very astute with valuations. And so, AirCap was already the largest lessor in the world. And then in late 2021, they bought the aircraft leasing portfolio GE Capital Aviation Services, GCAS, from General Electric. And when they did so, they gave them 111.5 million shares and paid $24 billion in cash, cash notes, to GE for the portfolio. This was big. Now, the debt or the cash stuff was just basically,

they were refinancing the debt that GE backstopped the planes with and they moved it over to AirCap-backed debt. That's not real. They didn't go find $23 billion in cash under the couch cushions. But it's at the point that they gave 111.5 million shares to GE when they bought them in November of 2021. Now, the selling shareholder in the secondary is not AirCap, although AirCap is arranging it. It's actually GE. We have pricing, it's $58.50. AirCap, so basically GE, they got 111.5 million shares in the deal. They're now filed to sell 23 million. They've given another 3.45 million to an underwriters option, which I'm pretty sure will probably be fully filled. And AirCap themselves are buying $500 million worth of stock, which is about 8.8 million shares,

from GE at $56.89. This is AirCap buying 3.5% of themselves back. We like companies that buy back their stocks and meaningfully reduce their share count. They're buying 3.5% of themselves back at a discount, both to the offering price on the larger thing that GE is trying to get out of, It's about 15% below what it was last week. Number one, I expected this, that this was going to happen, not because I've got a working crystal ball, but because this follows the playbook of what AirCap has done in the past. The last time we had a large major aircraft leasing portfolio being sold in distress from a company was some insurance company called AIG. About a decade and a bit ago, coming out of the credit crisis, AirCap bought AIG's leasing

portfolio. That's, I think, the transaction that made them the world's largest at that time. They bought that from a distressed seller. They, again, used leverage debt, and they issued a whole whack of shares to AIG. What happened over the next seven, eight, nine years is that the ample cash flows that AirCap generated first paid down some of the debt associated with the deal until they got down to a leverage ratio where they are comfortable. Again, debt is raw material for a lessor, so they're always going to run leveraged, but they got down to a level where they are comfortable, and then they switched the cash going from paying down debt to buying back stock, and including, they helped AIG, who was holding AirCap stock, they helped AIG

sell a bunch of the shares that they'd given to AIG in the deal back then, as well as they always participated buying some of that stock back. And so, something like, I think over the next eight or nine years following the AIG deal, AirCap repurchased about 80% to 85% of the shares they'd given to AIG in the first place. That only stopped because we ran into COVID and they turned off the buyback engine. But basically, to paraphrase Battlestar Galactica, all of this has happened before and all of this will happen again. It's exactly the same playbook being run on the GE thing. This is the first thing I wrote back in December in Hidden Gems Canada, where AirCap is a recommendation, we got it. Not at the COVID-inspired low, but pretty close,

we're pretty happy about that. I said, presuming it runs the same playbook as when they acquired AIG's portfolio a decade ago, expect AirCap to pay down debt until hitting a certain leverage ratio, and I gave the number, I said, which they just hit as of Q3 2022, and then likely turning to use its ample excess cash flow to start buying back the shares issued as part of the GE deal. They're doing exactly that. This is the first step. They're getting out from under the overhang of having GE owning about 46%, 47% of the stock. This will not be the last time AIG helps out GE to get out from under the overhang. This company, AirCap, is a tremendous capital allocator. They've consistently proved that, and I think the best is yet to come. Silicon

Valley Bank, bear cap. Awesome. You had me at ample excess cash flow. Always great talking to you. Thanks for being here. Thank you, sir. When you're a monopoly, you get some guarantees that other businesses don't. Marshall Zellinger is an investigative reporter for Nine News in Denver, recently covering Xcel Energy. Ricky Mulvey caught up with Zellinger to discuss how the utility company negotiates rate increases and the fundamentals of being a monopoly. You've been following Xcel for a couple of weeks now. And starting off, why are Xcel and utilities in general monopolies? Because it's legal. That's my

journalistic answer. We've had that question asked by many viewers. You compare it to phone companies, cable companies, now internet companies. One answer I got from someone just talking to me casually off the record is, it's a monopoly because when energy companies came to be, you needed uniformity. I don't even know why I try to say that word. You needed it to be uniform. Otherwise, you would have wires and cables from general sources going across alleys and across streets. Then it would be whose line is whose. They, the government, solved it for phone companies and for cable companies, now internet and satellite and all that. But when it comes to utilities, it seems to be the simplest thing

is that you've got your one-stop shop. So that's the start of it. But recently, a lot of people who pay utility bills have seen their prices go up dramatically. How have you seen Excel enjoy being a monopoly in your reporting? I'll be more down the middle. I don't know that they enjoy it. I mean, they have record profits. I think that's where that question gets to. In 2022, it was revealed through their filings and their fourth quarter reporting for financials was revealed almost $1.74 billion in profit over eight states. Their 10K financial filing that I saw two weeks ago showed in Colorado alone, where we're reporting from, $750 million of that came from Colorado. That was higher than

the previous year. I should pull that number up to make sure I'm getting it right, because I feel like the year before was $660. $750 might be high, maybe $730 or $727. Maybe it's $727 million, because I want to be accurate on that. While I stall, I'm going to make sure I am accurate on But nonetheless, the bulk of their profit comes from Colorado, and Excel covers eight states in all. I appreciate you being down the middle, but I think one benefit that they gained from being a monopoly, perhaps not in joy, but benefit, is that when they go about a capital improvement project, when they make an investment into a new building facility, that sort of thing, you've reported that they get a guaranteed rate of return on those investments, which is unlike

a lot of other businesses. Sure. Whenever the utility, and we'll just talk Accel here, goes to the Public Utilities Commission, the state regulators, it is built into, I think it's state law that it's built into, that you're going to have some sort of return on equity, or that that's allowed. Generally speaking, it was like 9% or 10%. The experts I've talked with say that's trending a little down lately. I will say in all my reporting, the one thing that I guess consumers benefited from was that Colorado's territory for Excel had the lowest return on equity. It was in the 8% range versus other parts of their territory, which were 10%. What that means is, basically, whenever they build

something, transmission lines, power stations, wind farm, solar farm, coal plants. They finance it on the front end, so they're out money on the front end. But they also have investors that help with that. And in return, the customers are paying them back for that investment. They love to say the word investment, and you can't see my air quotes as I say that now. We, as customers, pay them back for that investment plus. That's that return on equity. It's like, we're going to build this thing. We're going to finance it on the front end. It's going to benefit you. You're going to pay us back for it. Thanks for the 8% to 10% that we're going to get back in the long run. As someone said to me, hey, wouldn't you love to be able to invest in something and be guaranteed

8% to 10% all the time? You also looked at their relationship with the Colorado Utility Commission. how does Excel go about asking for rate increases and asking rate payers to pay things like their legal fees to ask for more rate increases? And that was interesting. That legal fees part, which I'll get into, was in the eighth of my now 18 stories on this topic since the end of January. Base rates are complicated. Base rates are something that's on your bill that's supposed to be every two years, it seems, is when your base rate changes. But there's also another line item on your bill that's supposed to take into account the price of fuel right now, the price of gas. That changes quarterly. The base rate includes everything they build, basically all

their employees. Anything that they buy that is used and useful is the term that was reiterated yesterday as the state lawmakers took a closer look at utility rates. So, anything that goes into your business, that gets included in the base rate and gets added that plus return on equity. But there's the other part that, hey, if gas prices suddenly went up and they had to pay more than they expected, they'll come back and say, we need to add this extra line item on your bill that covers the cost dollar for dollar for that fuel. And Excel will argue recently they've also gone back and said, hey, we didn't pay as much for fuel as we thought we were going to have to. So we're going back and having that line item lowered because that's dollar for dollar. And

since we paid a lesser amount, you're getting to pay that lesser amount also. But it's a really complicated process. And I set out on this journey by doing a what is on your bill story. What is each of these line items mean and why is it on your bill? Two stories that I thought I was going to do and then move on to other things. And that opened up this Pandora's box of viewer questions and educating people on something that you wouldn't think we need so much education on, something that we pay every month. And some of us do it blindly, not knowing what we're paying or why we're paying. And it's amazing how people have learned what we're all paying for, including those legal fees. Among the, hey, we're building this plant, we're buying this truck, we're paying

our employees, Excel got the Public Utilities Commission. They asked for $2.2 million in legal fee reimbursement for outside legal help that it hired to argue why it needed higher gas rates. The PUC ultimately said yes to $2 million of that $2.2 million. When you divide that over every customer. It's not a lot, but come on. They hired outside help to argue for why they needed to charge us more, and they got paid back for that outside help. Did you get any color on what those negotiations look like? I mean, there has to be some discussion from $2.2 million to $2 million. A lot of it, I have learned, is you're drowning people in paperwork. It is a lot of documents.

Think of it as a court case. It's evidence produced on paper instead of actually hearing from people. And I think there are testimony that happens along the way, not in front of the Public Utilities Commission itself, but perhaps in front of the, I may be speaking out of turn, but I think it's the ALJ, the judge that, it's basically a mediator-like judge that handles these types of things for the Public Utilities Commission, so that when the PUC ultimately makes a decision, it has all the evidence from all sides. And there's a proceeding that takes place ahead of that that kind of flushes a lot of this out. And what I think happened with that legal fee, it's in a document that says, it wasn't quite every line item of what

all the costs were, and that's why it got reduced from $2.2 million to $2 million, because there were arguments made from the public defenders of the consumer, the Office of Utility Consumer advocate. They made the argument, hey, Excel didn't provide enough paper to say, this is exactly why we're asking for this much money. It didn't say, this lawyer did this for this long. And some of that was missing, I guess. And that's why it got reduced from $2.2 million to $2 million. Early March here, there's a new committee at this state capitol of six lawmakers that are looking into rising utility rates. And in the first meeting it held, it asked about this $2 million. And the Office of Utility Consumer Advocate, which is, again, the public defender

of the consumer, argued, look, in base rates, customers already pay Excel for its employees, which includes lawyers on staff. Why aren't they just hiring more employees? And why are they hiring out legal help when they have in-house legal help. And oh, by the way, your bill pays for in-house and out-of-house legal help. And then the other thing that many rate payers pay for that I didn't realize before watching your reporting are things like rebates on solar installations and electric car charging ports. Am I correct? I think I might be wrong. So if someone installs an electric car charging port, a rate payer could be paying for that person's rebate? The rate payer has funded the account that allows that other rate payer to get that

rebate. So in a way, many states have this, a bag fee when you go to the grocery store. In Denver, and in all the states, it's a $0.10 bag fee. But in Denver, that $0.10 bag fee goes to a a climate fund. And as part of that climate fund, you can apply for e-bike rebates or electrifying your home with EV charging stations or changing out a furnace for a heat pump, things like that. You may or may not pay that $0.10 bag fee. You may choose to bring your own bag and never pay into that fee, but get the benefit of where that money's going. for your Excel bill, everybody has to pay into a line item that then funds the same stuff I just talked about. If you have an EV charging station need and you want to get one, you can apply to

have it installed and get some credit back from Excel, but that credit isn't coming from Excel from the goodness of their heart. That credit is coming from everybody who has to pay their Excel bill paying a line item that funds that account. Can't choose to not pay it. Marshall Zellinger, I really appreciate your insight and reporting on this, and thanks for joining us on Motley Fool Money. No problem. Thanks for having me.

As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.