Ken Heebner's World View
Ken Heebner has made tons of money for shareholders by astutely attuning CGM Focus fund to powerful economic trends and riding those trends like a cowboy atop a Brahman bull. Before 2000, lots of people forecast a bursting of the tech bubble, but Heebner put Focus's money on the line by shorting the high flyers in a bet that their prices would plummet, as they did. Then he invested heavily in homebuilding stocks just as their businesses took off. By 2004, Heebner steered Focus into energy and metals stocks -- yet another home run.
Moves like these propelled Focus into the top 10% of diversified domestic stock funds in four of the past seven calendar years (it finished in the top half or better the other three years). From the end of 1999 through February 27, CGM Focus (symbol CGMFX) returned a remarkable 25% annualized, thumping Standard & Poor's 500-stock index by an average of 24 percentage points per year. Heebner also runs CGM Capital Development (LOMCX), which is closed to new investors; CGM Mutual (LOMMX), a balanced fund; and CGM Realty (CGMRX).
As we sit down with Heebner this week in his office 45 floors above Boston Harbor, the question on our minds is where his instincts for broad economic trends are sending Focus fund these days. He doesn't disappoint us.
"The subprime mortgage disaster is much bigger than anyone can imagine," Heebner begins. Subprime mortgages are those made to borrowers who would otherwise not be given credit, and are largely unsecured in the event of default. Officially they come to almost $1 trillion, but Heebner is convinced that the amount of mortgage money in the hands of wobbly borrowers is even greater. He forecasts massive foreclosures -- a 30% default rate on subprimes -- as homeowners walk away and mail back their keys to lenders. As Heebner puts it: "It takes time for housing prices to go down to the point that people are under water. But when that happens, who is going to sit there in a $700,000 house that's now worth $500,000 and keep making the mortgage payment?"
But this is good news, Heebner explains, because the investment implications are counterintuitive. The effect of massive defaults will be to crimp consumer spending, and that will slow economic growth a bit and assure a longer life for today's bull market by causing the Federal Reserve Board to refrain from raising interest rates.
"I wish I could find a way to double my money" on the subprime debacle, says Heebner. "What I'd like to do is short the hedge funds, which I know own this stuff. They're buying mortgage-backed securities with an 8% yield and leveraging 10-to-1 or 20-to-1. They're going to be gone. But the mortgage holders we can short are small, and there aren't a lot of opportunities."
Heebner's biggest play these days -- 25% of assets at the end of 2006 -- is in investment banks: Lehman Brothers (LEH), Merrill Lynch (MER), Bear Stearns (BSC), Morgan Stanley (MS) and Goldman Sachs (GS). Explains Heebner: "They are in three new businesses. One is feeding the private-equity companies. I've seen a study that shows that between 2000 and 2006, the fees the investment banks got from private-equity companies equaled 10% of the assets of the private-equity companies. They are in the hedge fund business, too. Goldman has one. Finally, they sponsor these hedge funds by providing them with seed capital, providing brokerage services and making very profitable arrangements in terms of trading. As long as global liquidity remains robust, they will enjoy new avenues of profit."
How do you invest in the prosperity of farmers? Why, by owning John Deere. Deere & Co. (DE) is a 5% position in CGM Focus. The effect of the ethanol boom -- refineries are springing up across the Midwest -- is that corn prices are at record levels and staying there. "As we harvest corn and sugar to make hydrocarbons, we create a permanent demand for these crops," says Heebner. "That means that grain prices, which historically have only gone up when the weather was bad, are going to plateau. The agricultural sector is now endowed with a secular jump in its level of profitability. I was aware of this, but when Deere had its conference call recently and laid out the incremental demand for corn that ethanol was causing, the stock jumped $10. I don't think that most people who buy and sell stocks had been looking at corn prices." Farmers will have money to burn, and it's a good bet they'll buy lots more Deere farm equipment. (Read more about Deere & Co. as a global agricultural play.)
Heebner's investing style is hard to stuff inside a Morningstar style box. He calls himself a contrarian who looks for companies that will surprise people on the up side. One company with these characteristics is Las Vegas Sands (LVS), the casino operator. Run by Sheldon Adelson, the company has spread out from Las Vegas. There are deals now for casinos in Singapore, Macau and (get this) the former Bethlehem Steel plant in its namesake city of Pennsylvania. It's the Macau development that excites Heebner, who says it's not on the Wall Street radar yet. Macau is the former island colony that Portugal ceded to China in 1999. Chinese are renowned for their love of gambling, and Macau is China's Las Vegas -- except, as Heebner points out, Las Vegas took 40 years to develop as a gambling mecca and Macau is taking four. "If you want a direct play on the growth of Asian wealth," says Heebner, "this stock is it."
In Macau, LVS is already filling a swamp on which it is building eight casinos, along with shopping malls, condos and hotels. And the company is believed to be near an agreement with the government to develop nearby Hengqin with golf courses, convention spaces and hotels (but no casinos). The impact of all this on the earnings of Las Vegas Sands, says Heebner, will be electrifying. He cites a Goldman Sachs estimate that earnings will jump from $1.70 a share this year to $5.60 in 2008 and $6.85 in 2009.
We ask Heebner what would make him reconsider all of these investments. "Well," he replies, "if oil broke down to $30, that would derail the whole thing because the ethanol plants would close down. I don't see that happening. Also peace in Iraq, because Iraq has the second-largest oil production capacity. Investment banks would be hurt by a big decline in the stock market, and that could be brought about by higher inflation and higher interest rates. All these trends would be interrupted by a big decline in the stock market."
Significantly, when asked, he says he doesn't think Tuesday's 3.3% fall in the Dow Jones industrial average is such a decline -- more of a blip. Ken Heebner's world view remains intact.