Legacy Research Group

Chris Lowe: Hey folks. It’s Chris Lowe here from Legacy Research. I have a very special guest today. His name is Harris Kupperman, but folks call him “Kuppy.”

Kuppy is the founder and president of hedge fund Praetorian Capital. He also writes a very good investment blog called Adventures in Capitalism. And he recently launched his own research service, Kuppy’s Event Driven Monitor. Thanks for being on the show, Kuppy.

Harris Kupperman: Thanks for having me on, Chris.

Chris: For folks who don’t know you and what you do at Praetorian, maybe could we start there. What kind of investor are you? And what kinds of things do you look at on a day-to-day basis?

Harris: I like to think of myself as an inflection investor. I guess people don’t usually use that word, so let me explain it a bit.

I look at sectors that are inflecting in some way. Most of the world looks at linear progressions. Amazon grows every year. Apple grows every year. And because of that, there’s not a lot of opportunity to have a differentiated view.

I think the real opportunity to make multi-bagger returns comes from when you can look at something that’s inflecting and catch that inflection. I often look at sectors that are hard to model with quarterly volatility, annual volatility, sectors that have been beaten up and they’re really unloved. I find things in these sectors that are very cheap, they’re down a lot. And I wait for the macro tailwinds to come back.

It’s often cyclical businesses, and I ride the cycles. I’ve been doing this for 20 years. And I’ve been very successful at it.

Chris: Is that similar to what people often call “special situations”? Is that the kind of investing you do?

Harris: Sort of. But I think a special situation is more like what you’d see in my Event Driven Monitor, which I’d love to talk about. But special situations are usually foreign from corporate events. You have some sort of change of capital structure, change of business plan, spinoff, privatization to mutualization. These sorts of things create and unlock value. They’re all special situations.

But I prefer to look at inflections in underlying businesses caused by some change in tailwind. I think the most relevant one right now is… this time last year, oil was well below the cost of producing oil. It went negative and no capital got spent. You’ve had a dearth of capital expenditure (CapEx) for seven years now. If you don’t spend money to discover and produce oil, but the demand for oil goes up every year, eventually, the price of oil goes up.

Last year was a unique moment in time. Because of COVID-19, demand dropped. And the price dropped. There was a unique moment in time to buy energy assets in preparation for a recovery in pricing, which is what we’ve seen this year. That’s the sort of thing I’m doing.

Chris: I read a very interesting post from you on Adventures in Capitalism about the ESG [environmental, social, and governance-based investing] trend. You’re predicting a major blow-up in the energy markets. That’s one of the more fascinating events going on in the world right now. How is that impacting the oil trade?

Harris: It’s a really interesting thing. Historically, when the price of a commodity goes low, everyone goes bankrupt. And people stop investing.

The cure for low prices is low prices. And then, the price goes higher. And people start making money… and they start reinvesting… and there’s too much of it… That’s why you have these sine curves. That’s commodities going back thousands of years.

What’s unique right now is the price of oil is up, but people aren’t spending. Some of the largest oil companies in the world have literally said they don’t intend investing in oil anymore.

ExxonMobil got taken over by activists that really want to build windmills. They want to stop drilling and put the whole business into decline. You literally have activists that hate oil that took over an oil company.

Shell is having legal issues because of their operations. A rogue judge told them to get out of the oil business.

You have situations here in the U.S., where banks won’t lend to oil companies. You have the government canceling pipelines and permits and making it difficult to be an oil company.

This is happening around the world. Especially in Europe, oil businesses aren’t allowed to be an oil business. So you have this really countercyclical trend, where normally oil goes up, people start investing. Here, oil’s gone up and people are investing less than when oil was at $40 a barrel. It’s naturally going to make the price of oil go higher.

Because the funny thing about oil is that while everyone talks about the green economy, and we’ll eventually get to a green economy, you can’t transition because it’s not built yet. The technology isn’t there. The cars aren’t there. I mean, if you had 20 million electric vehicles (EVs) right now, there’s no electricity.

It’s a whole process to get there. And it’s going to take 20 or 30 years. They’re trying to cut off the carbon economy before they’ve built the green economy.

The net result is that the carbon economy’s going to overshoot in price. I think some of the people behind this ESG movement see that if they send oil to $500, and it costs you $25 a gallon, it’s eventually going to force people into the green economy.

I think they think an oil crisis is beneficial and it may help them achieve their goals. But it’s going to send oil to a crazy price, which will be great for me, but it’s probably not good for most people.

The other way to play it, and this is the other way I’m playing oil, is through a company called Valaris (VAL), the world’s largest owner of offshore drilling equipment.

If global demand for oil is going to go up two million barrels a year, which is roughly where it’s been for many years, one million to two million, and we’re right now into the S curve, where India, Africa, and China are in their adoption phase. That’s because six billion people want the same quality of living that one billion have, and their per capita consumption of oil is eventually going to catch up with mine.

So I think global demand for oil is going to go to somewhere north of two million barrels a year. That demand has to come from somewhere. If it’s not going to come from America – because we’re anti-oil here at the government level – it’s going to come from places that are happy to produce oil.

I think it’s going to come from offshore oil. You don’t need all the logistics and everything else to produce oil. Places like Guyana, Brazil, Angola, Gabon, and Nigeria don’t have much else. They need the oil revenue. They’re going to say, “Come, bring your drilling rig and produce oil. Pay us some taxes and take the oil.” So I think that’s where the incremental market share of oil’s going to come from.

A company like Valaris, which trades for about 15 cents of the dollar of replacement cost of the equipment, is a great way to play what’s happening in oil. It went bankrupt because it had too much debt and no one’s using offshore rigs. It came out of bankruptcy with more cash than debts. It came out of bankruptcy very cheap on replacement costs. It’s slightly profitable now. But as the demand for rigs increases, and their backlog is growing, I think it’s going to show a lot of profits. I think it’s going to see a dramatic recovery.