Monday, December 20, 2010

Brasil Foods long

Brasil Foods S A is new company formed by Sadia and Perdigão. Peridigao is the second largest protein producer in Brazil and the tenth largest company in the country. Before running into trouble with currency derivative trades, Sadia was a very profitable protein exporter to 110 countries. The combination of the two companies joins to high growth entities in the Brazil domestic market and abroad.

The author sees tremendous upside in BRFS as Brazil expands and the global economy recovers. BRFS is the second largest exporter of meats in the world, and thus will benefit from even a muddling world economy.

The company sells at a 14B USD market cap, in line with 2009 sales. Yet the company reported in 3Q 2010 it is growing at an 8% rate and guided to grow at 10-12% in 2011 due to continuation of the global economic rebound.

Risks to this investment include a rise of the Brazilian Real or fall in the USD. Brazil is also tremendous exporter of commodities so economic deceleration in China or around the world could cause significant problems for BRFS.

But while the world is living on stimulus and papering over economic problems, I am long BRFS.

The author recommends buying BRFS at $15.8.

Tuesday, December 14, 2010

Netflix: Another position


After discussing the issues facing NFLX with a friend who is an executive in the movie distribution business (DVD sales) with a major studio, I am even more encouraged that there is no upside to NFLX. But since the market can stay irrational longer than any of us can be solvent, I am entering another position of relative safety.

Buy Mar 2011 $290 Call for $.93
Sell Jan 2012 $290 Call for $8.75

Monday, December 13, 2010

Netflix : Viva la overvaluation!

Is Netflix taking over the world? One movie studio makes a multiyear deal to stream videos for dirt cheap back when no one was getting better than 3mb downsteam from their internet connection, and lives to regret it. Netflix now offers first run movies at $8 with an unlimited subscription. This current deal cuts out DVD sales and other revenue streams for the studios. There is little motivation for the studios to continue the deal in it's current form.

"The relationship between Netflix and the media companies will most likely change drastically, beginning next year when a deal between the company and Starz, the pay-TV channel, to stream movies from Sony and Disney expires.

The original deal from 2008, in which Netflix paid an estimated $25 million annually — a paltry sum, executives say, compared with the hundreds of millions of dollars cable and satellite companies pay Starz for the same movies — is now seen as a major coup for Netflix, and a major mistake by Starz. "(1)

Any major increase cost of content will hit NFLX bottom line hard. The current margins of streaming content is huge, but may not continue to be after the next deal. More importantly, it is diffuclt to see the company sustaining a P/E ratio of 69 with massive increases in costs.

The author will sell NFLX $280 strike Jan 12 calls at $12 and buy NFLX $280 strike Jun 11 calls $4.65

(1) "Time Warner Views Netflix as a Fading Star", Dec 13, 2010, New York Times

Monday, November 1, 2010

Fed Out of Bullets: QE2 will keep the status quo

Author: The upcoming announcement by the FOMC regarding QE2 will be a non-event. It will chart the course for allocation of huge sums of money toward a policy that will have little effect toward it's goal. It is estimated that the Federal Reserve will print US currency to buy assets to inject money into the financial system.

Regarding the planned purchase of treasury instruments: the only objective, and a noble one, should be to keep rates where they are, and not allow them to rise. At some point if they keep rigging the auctions too long, there will be a run. This is just prolonging the elevated pricing for the treasuries, but cant move the price any higher.

But I do see Fed continuing to buy hefty amounts of mortgage debt. The whole Fed strategy relies upon the mortgage market remaining steady and solvent. During the last few years a drop in long term mortgage rates has enabled a new refinancing binge that helps alleviate the overhang of underwater mortgages. Now that rates are near rock bottom, this trick has more risk of boomerang if the securities are deemed to be low quality at high prices. The implications are too horrendous if mortgage rates rise even a percentage point.

Prediction: Total of $500B USD purchase over six months, including $350B mortgage and $150B treasuries

Not enough to move the market, but enough to scary anyone away from shorting the market.

What does this mean?

1) USD should bounce
2) Emerging markets should correct mildly
3) Treasuries should hold steady for the foreseeable future (I think they will be successful in that)

For a retrospective look at what Helicopter Ben has hinted as options for QE2, refer to the following article from LA Times, July 22: "Federal Reserve gives us insight into Plan B"

"Fed Would Act if Needed, Chairman Says
Ben S. Bernanke, emphasized on Thursday that the central bank was prepared to take action if needed. (July 22)

In his testimony on Thursday, Ben Bernake warned of “unusual uncertainty” in the markets but said the Fed had no immediate plans to deploy additional tools of monetary stimulus.
“We are ready, and we will act, if the economy does not continue to improve, if we don’t see the kinds of improvements in the labor market that we hope for,” Mr. Bernanke told Representative Melvin L. Watt, Democrat of North Carolina, in the second of two days of hearings on monetary policy…."

"First, he said, the Fed could make clear to the markets that it planned to keep the federal funds rate, currently set at zero to 0.25 percent, for even longer than the “extended period” it has been projecting for months."

Author: uhhhh….this is called “do nothing and hope what we have already done eventually works”. Fed Funds rates are already at zero. I have read that the “real interest rate” with deflation counted in is currently 5%. But the nominal interest rate is already at the lower bound.

"Second, the Fed could lower the interest rate it pays on excess reserves — deposits banks hold at the Fed in excess of what they are required to — from its current level of 0.25 percent."

Author: uhhhh….are you kidding me? Is it really going to make that much of a difference to lower the excess reserves rate from .25% to 0%?

"Third, the Fed could expand its balance sheet, which already stands at $2.3 trillion, primarily by purchasing additional assets, whether in the form of additional government debts and mortgage bonds, or in the form of new assets, like municipal bonds."

Author: Ahhh… here we go…. More of the same thing done before…. Maybe something beyond mortgage bonds which can’t drop much lower than the current 5% yield. The Fed can start buying Greek bonds, Dubai debt, Spanish Banks, US auto loans, US credit card loans and everything else put on the market. I would hate to be a shareholder of one of the US Federal Reserve Banks right now. Forced buying does not make for very good return on investment prospects.

Friday, October 29, 2010

QE2 expectations are too big:Long USD

The USD is oversold. Reports are leaking that the Treasury bond broker dealers are telling Helicopter Ben that additional Fed purchases of Treasury debt may not be productive. Thus the Fed may buy mortgage debt or just reduce the size of the purchases. In any case, the markets have overestimated the interest of the Fed to push rates down further.

Sell UUP Jan 2011 $23 put at .93
Buy UUP Jan 2011 $22 put at .35

.58 upside with .42 downside with technical trends in your favor.

Tuesday, October 26, 2010

Technical Top - Time to benefit from hype

After this long bull run, it is time for the market to take a breather. The USD is at a historical support point, fiscal stimulus is peaking. It is enough to take a risk that the SPY (SSO) will not rise another 6% (12%) in the next three months.

The author has entered in the following position.

Sell SSO Jan 2011 $47 Call at $1.22
Buy SSO Jan 2011 $48 Call at $.98

Net credit .24 with $1 risk.

QE2? Be quiet. Long the 30Y bond

End of stimulus spending and heightened expectations of quantitative easing make treasury bond prices ripe for increases. Also housing is resuming price declines, pushing money to risk adverse areas of the market.

Sell Jan 2011 TLT $93 Put for $1.2
Buy Jan 2011 TLT $91 Put for .81

Net credit of .39 with a $2 risk.

Friday, September 17, 2010

Doubling down: Sallie Mae senior debt

With the sell off of Student Loan Corp from Citigroup to Discover, the market is finding undervalued assets in private student loans. Sallie Mae, as a third party involved in the deal, purchased a portfolio of $28B portfolio of FFELP, Federal backed student loans, from Student Loan Corp to service. This makes SLM, the 800 pound gorilla, even bigger in the FFELP marketplace. Sallie Mae will be able to use this leverage to support prices and manage supply in this market niche.

"While Sallie Mae will no longer originate FFELP loans, it will still be able to manage its existing $150 billion FFELP portfolio, which generated about $800 million in cash flow in the first quarter, according to analysts." (1)

Sallie Mae has bigger problems. The low interest rate environment hurts earnings because much of the their portfolio floats in a spread to treasuries. Thus the longer the Fed keeps interest rates low the lower the revenue base from the portfolio.

But the real concern is the outstanding debt and whether Sallie Mae will be able to continue to pay it's debt load. Bondholders like us want to know that regardless of the outcome with the company, we are paid what we are owed. A key analyst sees a margin of safety in the current value of the bonds, which are selling at 75cents on the USD.

"For bondholders, the key issue is not the viability of Sallie Mae's business model but the fact that its assets, conservatively valued, more than cover its $27 billion of unsecured borrowings, according to CreditSights. If the company did nothing to restructure, it would have enough value in its current book of business to service its debt, CreditSights analyst Adam Steer said in an interview." (1)

So assuming bonds will pay out at par there is a 25% margin of safety while accumulating a 8% return on investment. Excellent risk reward ratio to the author.

Long SLM again at $19.1 (NYSE: JSM)

(1) Reuters, July 2010

Sunday, September 5, 2010

Maybe a weather man would be better

Everyone knows that the there is no better job than the weather man. Every morning this person checks the lastest satellite images for the latest weather trends without insight to cause and tells the public with the utmost confidence what the day will bring. What sets apart stock market analysts and weathermen is belief in an observable and discernable causality. We don't know what makes the weather. We do know what makes money.

Recent data from the US economy makes the weather man look rather insightful. The mixed influence of a worldwide slowdown and a stimulus has the economy giving strange signals. As recently as July, the technology bellweather, Intel, raised guidance for the year by 10% on high demand. Then just three weeks later the company recanted their upward guidance and stated they will achieve the lower end of their original guidance.

Then on the premise of an upside surprise on the August ISM manufacturing index, the market bounced and gained 5% on renewed optimism. A few days later, when the much larger services sector index underperformed showing only slight growth in the August and the July factory orders index came in below expectations, the market showed no reaction.

It is impossible to tell what is driving the economy right now, or if it is growing or falling off. Many analysts can point to many different data points, but they should defer to a professional who is comfortable with extreme uncertainty. The safest person to ask the direction of the market is to ask the weatherman.

Tuesday, August 24, 2010

Bernanke, Obama, and Pelosi are in a box: Long volatility again

For the last year the government and the Federal Reserve has pulled out the stops for financial stability. They have performed every feasible measure to make the system stable and the market secure. Mohammed El-Erian, a voice of the bond vigilante, has expressed that monetary policy will have a neglible effect going future. These measures have only delayed inevitable deleveraging.

As the Q3 starts and stimulus begins to have a negative effect on growth, there will need to be a change in expectations to experience the anemic economic situation that we are currently experiencing. This change in expectations will make the current stock prices look expensive and unsustainable.

Any additional measures will come from fiscal stimulus. But the Republicans think they can take Congress back in November and thus will hamstring any Obama or Peloisi initiative between now and then. Thus if any issues appear, there is significant political risk to any solution. This will create a significant possibility large volatility between now and then.

Why not take advantage of that?

The author is long VXX at $19.

Thursday, July 29, 2010

Turkcell: A Demographic play

"Production depends upon people, not only in the actual process, but because of the final demand that justifies its existence. The more and more consumers, the more and more need for things to be produced. I will go so far as to say that not only growth but capitalism itself may be in part dependent on a growing population."

Bill Gross, PIMCO, August Investment Newsletter

Turkcell is a company that has great prospects from being the #1 wireless provider in Turkey. Turkey has a median age of 27.2 and 25% of the population is under the age of 14. This means that there are huge demographic forces that will increase overall demand for wireless services in the Turkish domestic market.

Add a great balance sheet, significant growth prospects in Eastern Europe, and solid customer satisfaction ratings, and Turkcell is a great long term holding.

Long TKC at $15.

Riding Gold again

Until the Fed looks to begin raising interest rates, the price of gold will not fall.

Sell $115 Sept GLD put at $3.5
Buy $112 Sept GLD put at $2.6

Friday, July 9, 2010

ECB sends out more propaganda

The recent news regarding the sovereign debt crisis is not passing the smell test. It seems that the ECB bought right up to their spending limit ($60B euros) and then called the damage control a success. It has been mentioned that Greece has possibly met most of their funding needs for this year. But it is wreeks of a PR campaign to claim victory and hope no one looks as the medicine starts to really take hold and show if it works. Growth is fleeting across the Euro zone, deposits are fleeing Greek private banks. The real test has not even started.

Buy VXX any time it falls below $24. Sell the next time one of the PIIGS needs to refinance when the VXX is above $30 again.

"ECB Signals an End to Aid Program

FRANKFURT—European Central Bank President Jean-Claude Trichet said strains in European financial markets are starting to ease, suggesting the ECB will continue to pare a program to help the region's most-vulnerable countries get back on their financial feet.

The ECB left its key rate unchanged, but all eyes remained fixed on Trichet's press briefing, where the central bank president is expected to soothe concerns over bank liquidity. Dave Kansas, David Weidner and Bob Davis discuss. Also, Ianthe Jeanne Dugan discusses the pain that impacted many hospitals after their derivative bets went bad.
Under the program, which was designed to jump-start dysfunctional segments of the financial markets, the ECB began purchasing government debt in May.
"What is needed in terms of interventions [in government-bond markets] has been progressively diminishing," Mr. Trichet said Thursday after the ECB's monthly meeting.
He rejected concerns that a weaker global economy, and fiscal belt-tightening in Europe, might push the region into another recession, saying investors have been too pessimistic on the currency bloc's economic prospects.

ECB President Trichet dismissed the chances of a double-dip recession.

Mr. Trichet said he is happy with the central bank's monetary stance, suggesting the ECB may keep its main lending rate at a low of 1% for many more months. He said that markets are showing increasing confidence in European officials' ability to manage the crisis.
The ECB has purchased nearly €60 billion ($75.6 billion) in government debt of Greece and other vulnerable countries such as Portugal since the program started on May 10. But the amounts have dwindled after a brisk start, averaging only about €4 billion a week since mid-June. The ECB bought more than €16 billion in bonds in the first week of the program.
"He sort of showed his hand a little bit that they are in the exit" phase, said Erik Nielsen, chief European economist at Goldman Sachs.
Government-debt purchases by central banks had been taboo in Europe, particularly Germany, where the practice stokes fears of a loss of central-bank independence and increases in the money supply, which could lead to inflation. Germany's central-bank chief Axel Weber, a member of the ECB's governing council, has been a vocal opponent of the plan, exposing a rift between the ECB and its largest member country.
Mr. Trichet declined to offer an end date for the program or to specify conditions in markets under which officials would terminate it, suggesting the ECB will continue to buy bonds in small installments for at least a few more weeks, analysts said.

"They may be trying to buy some time" until a €750 billion EU-IMF stabilization fund is operational, said Nick Matthews, an economist at Royal Bank of Scotland. European leaders agreed to set up the fund on May 10,the same day the ECB started buying bonds, in order to prevent Greece's debt crisis from spreading to other countries in Europe's periphery such as Portugal and Spain.
Also Thursday, the Bank of England's Monetary Policy Committee left its key interest rate unchanged at a low of 0.5% to help cushion the economy against the effect of deep cuts in government spending.
The decision was broadly expected, with many economists also predicting the Monetary Policy Committee would maintain its bond purchases, made through its quantitative easing policy, at £200 billion ($303 billion).
Mr. Trichet declined to provide fresh details on bank stress tests, but gave the exercise a nod of support, saying, "We expect that the tests will be confidence-building." The Committee of European Banking Supervision, a London-based body that groups national authorities, said Wednesday that 91 European banks will undergo stress teststo see how their balance sheets would withstand shocks including a double-dip recession and a sovereign shock that generates losses on government bond portfolios.
The ECB president on Thursday continued to warn, as he has for manymonths, that the region's economic recovery will be "uneven." Europe's recovery from the worst recession in decades has been modest so far in comparison with stronger rebounds in the U.S. and in developing countries like China and India.

Rate changes since 2004 in dozens of countries.

Still, after expanding less than 1%, at an annualized rate, in the first quarter, the euro-zone economy should grow around 3% in the April-June period, said Greg Fuzesi, economist at JPMorgan Chase. That's due in large part to a strong pickup in Germany, which accounts for about 30% of the region's gross domestic product. Reports Thursday on exports and factory output point to second-quarter growth of around 6%, at an annualized rate, says Ralph Solveen, economist at Commerzbank.
In a departure from his practice of speaking of the euro zone only in its totality, Mr. Trichet specifically highlighted the German figures Thursday. For the euro zone as a whole, "the second quarter is likely to be much better than the first quarter," Mr. Trichet said. He dismissed the chances of renewed stagnation or a double-dip recession.
Write to Brian Blackstone at"

Sunday, June 27, 2010

Why you should go long BP - carefully

The Deepwater Horizon tragedy has been a fiasco. BP will owe billions and will continue to pay materially and in creditibility for many years. But despite all of this, BP will still exist when the noise dies down.

1) Energy security depends on it

BP owns well developed and yet to be developed strategic oil interests all over the world. BP owns interests in Azerbaijian, Angola, Brazil, and Norway. BP has also strategic rights to potential deepwater sites that could hold vast fortunes of oil resources. In bankruptcy, foreign governments may lose faith in US and Britain organization may lose these assets to major competitors from China and Russia. This is much more threatening to the administration than even the clean up effort.

2) BP is as much an American company as it is British

The current form of BP is the result of a merger between legacy BP, and Aramco, the legacy Standard Oil, in 1998, and a purchaser of ARCO, the Atlantic Richfield Co. in 2000, another major American oil producer, and Burmah Oil, PLC. The resulting company is the largest oil producer in the world. But the legacy of the company makes over 40% of the existing shareholders attributable to the Standard Oil and ARCO firms, and thus American interests. Moreover, over 23,000 of 80,000 BP employees are in the US.

So often in the debate about BP there has been accusations that the US government should punish foreign interests for their irresponsibility. Instead, the history of the firm points to a long history of American shareholder interest in BP. The US government has no interest in penalizing the firm to the detriment of US shareholders unless absolutely necessary

What to do?

Although the US government has had blistering criticism and threats to the BP organization, Bloomberg has reported that Obama said on June 16th "BP is a strong and viable company, and it is in all of our interests that it remains so." Thus if the US government has no interest in bankrupting the company through punitive measures, then someone needs to tell that to the bond market. BP bonds are selling at a 10%+ discount to previous prices. This offers a significant opportunity to the prudent speculator. Bill Gross, the founder of PIMCO, has already taken the leap and currently owns millions of subordinated issues.

Long BP Senior Debt "E" Series and Long BP Subordinated Debt

Thursday, June 24, 2010

Ally Financial: Fighting the tide

GMAC Financial, now Ally Financial, is a wonderful example of a company who is making it's best effort to stabilize after a large US bailout.

Ally Financial, with liabilities of over $200B and a significant portion with dubious quality at the time of reckoning, received a total $20B infusion from the US Treasury in March of 2010 through the conversion preferred shares into common equity. With that, the Treasury essentially recapitalized the whole company and at the end of Q1 2010 had $14.8B in cash and cash equivalents. With stimulus across the world, Ally has been able to write up assets and unload risky assets from their balance sheet.

To that end, Ally Financial sold off it's European mortgage assets (1) but has continued exposure to Europe in auto loans and other areas.

This month, Ally Financial has attempted to securitize mortgage securities again by offering a senior not on a $166m mortgage pool with %25 credit enhancement.(2) This means that the pool of low LTV loans and prime borrowers can withstand 25% losses before the senior bond is at risk. The senior note was graded A by Moody's. The auction will not occur until next month.

Overall, Ally Financial is making great strides to reduce risk and return tradtional banking practices. It is still yet to be determined whether the company can stand on it's own. But due to the critical function the company performs in supporting the American auto industry, the implicit support from the US government will provide significant credit protection for all investors.

The author is long GKM until maturity.

(1)"Residential Capital (ResCap), the mortgage subsidiary of GMAC Financial Services, is selling its European mortgage assets and businesses to affiliates of alternative asset manager Fortress Investment Group (FIG: 3.37 -3.44%).

The transaction moves 10% of ResCap's total assets as of year-end 2009 — and 40% of total assets when adjusted for the required Financial Accounting Standard (FAS) 167 treatment of off-balance-sheet securitization — into Fortress ownership.

ResCap said the assets in the transaction are valued at levels established in Q4 2009, and it expects no material gain or loss from the transaction. With this deal, GMAC is essential out of the European market."

(2) "Moody's Investors Service assigned provisional ratings to a senior note issued by GMACM Mortgage Loan Trust Series 2010-1, a new residential mortgage-backed deal.
The securitization is sponsored by General Motors Acceptance Corp. Mortgage (GMACM). According to a source close to the deal, GMACM Mortgage Loan Trust 2010-1 priced on Tuesday.

Moody's has assigned a provisional single-A 2 status to one senior note with an original stated value of $166.35m. This note is supported by a subordinate certificate with an original stated value of $55.45m, which Moody's did not rate.

The transaction is backed by 1,981 loans with a combined unpaid principal balance of $222m originated and serviced by GMAC. Loans insured by the Federal Housing Administration (FHA) make up 97% of the pool, with the remainder insured by the US Department of Veterans Affairs (VA)."

Monday, June 21, 2010

Reiterating - Gold is going higher

I have taken great interest in the gold debate. Here is what I have found...

There are two major laws to investing in gold.

(1) Gold tracks neither inflation or deflation as a rule, instead gold tracks financial instability

In periods of financial instability, there is a rush to safety to buy treasury bonds and the like. Investors also become skeptical of paper currency. That is a strong bullish case for gold.

(2) Gold consistently increases when short term interest rates are at nominal zero

When the Fed is pumping money into the system to fight whatever financial ill is in the system, this is also a bullish scenario for gold. Right now, the Fed is trying to unemployment and financial instability. Both drivers warrant an extended period of low interest rates. So when will the Fed raise interest rates?

(1 + 2) The Fed historically has only raised rates six months after unemployment starts to fall from peak levels

Based on the current reports regarding the dwindling stimulus and the temporary census jobs boost, unemployment should decline from current levels for the rest of 2010 and early 2011. Thus with the instability in Europe, and these structural problems in the US, the Fed will keep interest rates low as a safe strategy. This is an "all clear" bullish sign for gold for the rest of the year.

Wednesday, May 12, 2010

Gold is on the rise

No confidence that more loans will resolve the issue of too many loans in the Euro Zone.

Gold is the play of social instability.

Selling GLD Jul 10 $118 puts for $4.5 and buying $115 GLD Jul 10 puts for $2.9

Thursday, May 6, 2010

Ignore the credit raters! Buy GMAC Senior Debt

The author is adding another safe investment with a US government "put" to support the security. The intent will be to hold until maturity.

The whole investment logic for this one is supported by a quote from Bill Gross, PIMCO, in his May Investment Outlook

“Still, as future bond issuers belly up to the bar with their rating agency seals of approval, it is incumbent on the buying public to treat those IDs with a healthy skepticism. Firms such as PIMCO with large credit staffs of their own can bypass, anticipate and front run all three, benefiting from their timidity and lack of common sense. Take these recent examples for instance: S&P just this past week downgraded Spain “one notch” to AA from AA+, cautioning that they could face another downgrade if they weren’t careful. Oooh – so tough! And believe it or not, Moody’s and Fitch still have them as AAAs. Here’s a country with 20% unemployment, a recent current account deficit of 10%, that has defaulted 13 times in the past two centuries, whose bonds are already trading at Baa levels, and whose fate is increasingly dependent on the kindness of the EU and IMF to bail them out. Some AAA!

Now let’s go the other way. GMAC, that only too recently near-bankrupt finance company, carries recently upgraded B ratings from the rating services. Profiles in courage for all three, I say! I mean the U.S. government has injected $20 billion of capital and owns 65% of the company. It’s the auto industry’s equivalent of FNMA and FHLMC, except those are AAA and GMAC is B with a “positive outlook!” For that, you can buy a GMAC two-year bond at 6½% (8% with what are called “smart notes” that Investment Outlook readers can buy through their broker), while you receive only 1.2% at Fannie and Freddie. Vive la différence!”

The author of this blog has found something comparable to purchase…

NYSE: GKM – GMAC Senior Debt, 7.25% yield at par ($25), currently priced at $20.85 (8.69% yield to maturity) – Callable any time after 2008 and due 2033
NYSE: GJM – GMAC Senior Debt, 7.35% yield at par ($25), currently priced at $21.02 (8.69% yield to maturity) – Callable any time after 2008 and due 2033
I am going to buy a little of both of the above for myself right now. FYI: When they retire the debt, they normally start with the higher yielding one first.

Bought GKM at 20.96 on May 5th and sleeping well.

Wednesday, April 28, 2010

Stimulus, Strikes, Restructuring and Stability? - Go Long Volatility

This looks like an absolute no brainer.

We are at the top of the stimulus, 70% of the money will have been spent by September. Stimulus programs are fading out all over the world (except maybe China).

On the other hand, Spain, Portugal, and Greece have all been downgraded and face further market pressures on their debt this year. According to NakedCapitalism, Greece is going to face the most stringent economic constraints ever placed on a sovereign nation to receive their IMF alottment. That will just delay the problem for six months to a year. Once they blow through the first set of conditions, the market will be bigger questions to address.

I don't care if the IMF (a.k.a. US) and it's european friends bailout all of these PIIGS. They won't do it until it is the final option. That guarantees volatility before we get there.

Long VXX at 20.06.

Deleveraging is in effect and it is ugly.

Monday, April 26, 2010

First Marblehead recovers from a bump

Investing in FMD takes pure guts! (Or just faith in the vampire squid)

FMD has $422m cash ($380m market cap) and a $15m quarterly burn rate. Yet it has no real income because it was forced to stop all banking transactions because of it's capitalization levels and loan guarantees. It continues to take shrinking losses on that previous portfolio. The government lifted the cease and desist order on their bank subsidiary after they sold off their complete student loan portfolio at a sizable loss. So now they can get back into the business in a much better market climate than before.

For me, it is impossible to believe that the private student loan securitization market is permanently impaired. There is plenty of supply of private student loans to be made out there. There is plenty of demand for it from investors due to the strict recovery provisions. FMD servicing capibilities have proven to decrease default rates and increase recovery rates, crucial for student loan securitization investment returns.

A first peek of sunlight is a recent agreement with Sun Trust to perform $200m worth of loan processing, production support, program support and portfolio management, and program administration services. There is no timeframe yet in regards when they will execute this program.

So I think there is a market for them, it just has not reemerged yet. Others have made this bet before, but have yet to realize a return. But with the recent SunTrust deal, real revenues are on the horizon.

Finally, I can say all of these wonderful things, strike them, and still say the fact that Goldman invested $1B in private equity and has a vested interest in seeing a return on that investment is a good enough reason to dabble in FMD. Does anyone have a doubt about Goldman's ability to find a profit, ethical or not? I did not think so.

The author is long at $3.57.

Thursday, April 22, 2010

Oil subsides but is still potent for upside

Oil continues to strength against massive supplies in the US.

"Oil inventories at Cushing reached 34.1 million barrels in the week ended April 16, less than one million barrels shy of a record, the U.S. Energy Information Administration said Wednesday. The extra oil has few outlets, with stockpiles across the Midwest at their highest in at least 20 years and refiners already producing enough fuel to further inflate gasoline and distillate inventories."

Supplies at the highest level in 20 years and oil is still above $80/barrell. Wow.

'"Oil prices have managed to remain above $80 a barrel largely due to strong demand out of China, which has exceeded expectations for economic growth over the last 18 months, even as U.S. oil demand has underperformed.

"The shift in the epicenter for demand continues to shift east of the Suez," wrote analysts with Barclays Capital.'

Yet this may not be the end of it. If the Chinese yuan increases, then oil could go even higher if their stimulus is maintained while the currency appreciates and thus the buying power of China increases.

Short the runt PIIGS

This will be a drawn out process. But we can be sure that Greece will default in some form or fashion (i.e. restructuring). In the meantime, let's enjoy the instability and make some money shorting the national champions of the most at risk PIIGS.

A few of the facts:

*There is a run on the banks going on in Greece already, official or unofficial. Over 25% of deposits have already left the domestic banks.
* Only six people in Greece claimed income higher than 1m euros in 2008 (pervasive tax evasion)
* Greece has spent over 50 of the last 200 years in default (subprime, always)
* Greece has not had fiscal discipline in the last 10 years, why will that change in a major recession?

As for the short of Portugal Telecom and the national electric company (EDFPY.PK), the performance of the telecom and energy industries are tied to the economic health of the country.

Short NBG at $3.10 entered on 4/22
Short PT at 11.00 (limit order)
Short EDFPY.PK at $37 entered on 4/22

Thursday, April 15, 2010

Going to school with Sallie Mae

Moral hazard is alive and well, why not make some money off of it? A great candidate is Sallie Mae.

Recent policy changes by the Federal government banned the private origination of Federal student loans, Sallie Mae's most profitable activity.

As a result, Sallie Mae has contended that it will need to layoff 2000 workers as it retools to be one of the four designated Federal student loan servicers.

This rebalance in revenue streams pales in comparison to the current liquidity issues facing Sallie Mae. In 2010 and 2011 Sallie Mae is facing a rollover of $11B in debt with only $6B in cash and a hostile credit market. In March Sallie Mae completed a new 1.5B 10-year offering at a horrific 8% fixed. Although this is horrific at first glance in comparison to their current lending rates (5.5% - 6%), since Federal loans often float with interest rates, a rate increase could make this offering cheap in comparison to the discount rate.

Bottom line, the author believes that the Federal Goverment will do whatever it takes to make sure Sallie Mae can rollover their debt. It is not in the interest of the Federal Government to have another major lender fall due to a lack of liquidity, and that has been the minimum criteria for applying moral hazard.

So what do we do? Buy Sallie Mae senior unsecured exchange traded debt (NYSE:JSM) yielding close to 8.3% ($18 price / $25 par) maturing 12/15/2043. Buy at the limit price - $17.50.

Monday, March 29, 2010

Bank inflexibility may lead to government forced writedowns

Currently there is growing pressure to relieve homeowners by forcing the banks to reduce second mortgages on properties.

From the Wall Street Journal…

“Pressure is growing on U.S. banks to ease terms for distressed homeowners on home-equity loans and other second-lien mortgages. Rep. Barney Frank, chairman of the House Financial Services Committee, last week sent a letter to the four biggest U.S. banks demanding "immediate steps to write down second mortgages."

It appears that the banks enjoy the current lending environment but do not want to concede to rectify the burdens carried by underwater homeowners.

What I read in the bible this morning…

Proverbs 28:8

“ 8 He who increases his wealth by exorbitant interest
amasses it for another, who will be kind to the poor.”

The government may be the instrument that makes the banks recognize their losses and allows the house poor individual to shake free of their debts. But if that is done, the banks could face another major capital problem.

“Most first-lien home loans are held by the government-controlled mortgage companies Fannie Mae and Freddie Mac or by other investors in mortgage securities. By contrast, banks hold most of the seconds and other junior-lien mortgages. About $1.05 trillion of junior-lien home mortgages were outstanding as of Sept. 30, according to the Federal Reserve. Of those, $766.7 billion were held by commercial banks; most of the rest were owned by savings banks and credit unions.
If banks are forced to write down or write off large amounts of those second mortgages, many would suffer major dents in their capital. Laurie Goodman, a senior managing director at mortgage-bond trader Amherst Securities Group LP, said regulators may need to allow banks to recognize losses on second-lien loans over an extended period to avert a disastrous immediate hit to their capital.”

Even though the loss should be recognized immediately, the banks will continue to carry the loans above market prices until forced to do so. But something could go wrong with the bank's plan. This will be an interesting issue to watch over the next few months.

Friday, March 12, 2010

Time to hold your nose and jump into China???

The China market stinks of government induced economic growth. Since November 2008 I have been highly skeptical of the ability of the world's biggest exporter to sustain economic growth in the face of major declines in import in advanced economies. I was even skeptical that the China stimulus would even be able to solve their problems temporarily. Yet once again I have been proven wrong and see an undeniable trend...

"Chinese exports jumped 46% y/y in February 2010 to US$94.5 billion, after a 21% y/y gain in January. The move suggests that China’s export recovery continues, supported by global demand, but the pace of growth has slowed on a seasonally adjusted basis in early 2010. The 45% y/y climb in imports, reflects in part the revival of the processing trade in which components are imported for re-export as well as the sharp increase in commodity prices."

At the beginning of 2009 exports from China had dropped 20% yoy. With stimulus, exports jumped 45% from 2009 levels but that equates to a 16% increase over 2008 levels. That just returns the country to the growth course it assumed before the crisis began (approximately 7.8% annually).

So is it time to go long China? Probably not. There has been so much positive feedback to the people who have been holding shares of Chinese companies it is hard to see new buyers coming. That said, there has been very little decrease in the stimulative monetary policies of the Chinese government.

As noted in my previous post, oil consumption points to increased economic growth and more upside to the market. But I am not convinced. Nor am I adventurous enough to wade in treacherous waters. I may be missing a huge opportunity, but a penny saved is a penny earned.

Wednesday, February 24, 2010

Oil: Another China play

Some said it was the USD holding up the oil price. Now the USD has retraced to pre-crisis levels vs. other major currencies and the price of oil has not fallen.

As it turns out, China imports are a large catalyst in demand for crude oil.

“China’s growing reliance on seaborne crude oil imports will set the tone of the tanker market for the coming decade,” Poten said in a report to clients, quoted by Bloomberg. “China’s expanding middle class, strategic stockpiling and complex refining capacity ensure that it will continue to be a large ship, crude oil story.”

What is strange is that overall world demand is down, but since China is buying, prices are up. This is somewhat understandable because 50% of the oil futures contracts traded are for speculation. So it is a self feeding machine.

In any case, based on this information I will be looking for an acceptable exit point for my SCO position. I cannot invest with 80% confidence when I see I am fighting the Chinese stimulus investment in oil consumption. I will need to wait to see lending decline prior to taking such a position again.

"China’s crude oil imports may reach an all-time high this year as an economic recovery spurs demand for fuels, data from China National Petroleum Corp. showed on Feb. 4. The Chinese economy, which expanded at the fastest pace in the fourth quarter since 2007, will grow four times faster than the U.S. in 2010, the United Nations said in December.

Chinese charterers accounted for about 30 percent of VLCC spot fixture activity this year, up from below 5 percent a decade earlier, Poten said."

Turkcell on sale

Simple market thesis, find a wide moat, buy and hold. Easier said than done.

Turkcell, the #1 cell phone provider in Turkey is one such company. Beyond the huge domestic market share (57%) and wonderful dividend policy (50% of profits to shareholders), this company holds a huge economic moat. The mobile telecom market naturally requires huge capital investment, and thus the barriers to entry are huge. Also, as in most emerging economies, telecom companies are often partially privatized but still national champions of the current regime. Turkcell is no different. No one in Turkey wants Turkcell to fail.

Purchasing this stock with .79 cent dividend (5.1% yield at $15) does incur currency risk. But economy of Turkey has held up very well in the recent economic crisis and has even been marked for a rating upgrade by the major rating agencies.

Although a large part of Turkcell is already foreign owned, at some point in the future I could see a major multinational moving in and buying Turkcell to extend their geographical footprint. But for now, I am content with the high growth and high yield.

The author is long TKC at $15/share.

Tuesday, February 23, 2010

What Euro crisis? I smell opportunity. Buy Euro debt

Headline: Fiscal deficits across Europe threaten to blow apart the Euro.

So what? Who cares.

Let's think about this. Germany is right now benefiting from low budget deficits and artificially lower currency base because they belong the Euro. Exports are recovering because Germany is one of the most competitive exporters of the European Union.

Let's look down the road... worst case, one of the PIIGS default. The euro is abandoned by the European countries and the deutsche mark (DM) is reinstated. The DM soars and exports suffer. Another recession ensues. Painful, not a killer.

More likely...the PIIGS are dragged along without "technically" defaulting. A bailout, backdoor or front door, will just continue to dilute the euro trying to regain competitiveness. The German banks will take some writedowns and move on. Is this bad? Bad for Europeans trying to retire. But not bad for the survivor PIIGS who need to export their way out of their recession.

With this said, what could be on sale during this storm?

Long Credit Suisse Subordinate Debt Notes yielding 7.90% at par ($25 Par), buy at $17/share (NYSE:CRP).

Long Deutsche Bank Subordinated Debt Notes yielding 6.35% at par ($25), buy at $13.5/share (NYSE:DUA).

Wednesday, February 17, 2010

US Deficit Management: Feeling in the dark

If there is anything that keeps stomach of the average US investor in a knot, it is the size of the US deficit. For all the story of US growth prospects, with the deficit always looming in the background, there is a feeling that whole system could fall to piece if this issue is neglected. The US deficit is huge. At this time of economic stress, it is important to ask if US at immediate risk? If not, what are some scenarios which could be a tipping point?

Right now, the US is not considered to be a major risk. The US has no problems rolling over their debt at any maturity. We don't know how long that will be so easy. Yet there are other countries with more immediate debt concerns that may be a canary in the coal mine.

Yet as the Economist notes above, the US one of the lowest average duration measures of all heavily indebted countries.

As a course of the recent stimulus financing, the US has been selling heavily into the middle of the medium term of the yield curve. This helps by lowering debt payments on debt rolled over. In fact, the US has actually reduced their interest payments in 2009 recently because of our focus on issuing debt in the 3yr to 7yr range of the yield curve.

Essentially is a leveraged bet on the future economic growth and fiscal management. If there is an econmic shock or significant inflation causing higher interest rates in a 2.5 to 6.5 year period, the rollover of the remaining debt will cause a marked increase in debt servicing payments. This is particularly of concern because the overall US debt schedule will be so focused on the front end of the yield curve causing a massive rollover of debt in just a few years.

Who knows if we will be ready, or just in worse shape from kicking the can down the road, when that time comes?

Scenarios that could cause US debt to become a noose....

1. China decreases consumption of US debt

If China reduces stimulus too fast it's accumulate such massive amounts of foreign currency and becomes a long term net seller of US debt instruments

2. Japan decreases consumption of US debt

If Japan faces a large deflationary spiral or exports do not recover, it must decrease purchases to amortize it's own debt

3. Oil producers decrease consumption of US debt

If a world wide economic slump causes the price of oil to drop, some major oil producers (Middle East, Russia) who also are responsible for purchasing 10% of US Treasury debt, decrease purchases and unload their holdings

Deficit hawks, doves, and peacocks can crow all they want about deficit reduction or increased deficit spending. The looming threat of a debt crisis will remain until there is a cultural transformation regarding fiscal management to reduce short term borrowing needs.

Tuesday, February 16, 2010

USD bull momentum continues

Many doubted the USD. Called it dead and buried.

The USD has started to prove a better choice amongst world currencies. Analysts observing the change in the situation have revised estimates of the 2010 value of the USD vs Euro to reflect the trend toward USD strength.

In fact, large amounts of money has also started to point toward continued USD strength.

"According to data compiled by Scotia Capital, traders were net short the euro—meaning on balance they were betting it would decline—by a record $9.9 billion last Tuesday.

That is a 31% increase from the previous record set a week before. Traders were net long U.S. dollars by $7.9 billion, on a par with levels last seen during the financial crisis."

Once again, there are huge deflationary forces taking hold this year....

1. HAMP ends, massive short sales to ensue
2. Agency mortgage purchases by the Fed end (at least for a little while, may restart later)
3. QE using treasury purchases end (again, probably temporary - six months at most)
4. World wide stimulus programs end (South Korea, Brazil, Australia, India, etc)
5. No cash for clunkers
6. Declining influence of the US fiscal stimulus

... and many more

Plus the "flight to the USD" effect from...

1. Euro zone debt crisis
2. Dubai "restructuring" (default at 60 cents on the dollar)
3. Would you put your money in China an export economy with stimulus at 20% of GDP???
4. Massive Japanese QE (Not here yet, but definitely coming by May, no doubt)

Even though the US has huge debt problems, compared to other countries, their issues look reasonable. The Economist ranks the US and UK after the PIIGS for sovereign debt risk.

The flaw the US is the relative short maturity date of the debt. But one crisis at at time. For now, there is no problem rolling over US treasuries in short maturities and thus the USD IMHO is still on a long bull run.

Monday, February 15, 2010

As much as I would like to do it again...

... it seems the rules of the game have changed.

Back when the world was simple and the banks were audacious enough to mark-to-market, a novice speculator like myself could use news of credit events to short banks before the losses were annouced. But even credit agency reps admit, this is no more...

"The recent credit crisis was over a few trillion in bad, mostly US, mortgage debts, with most of that at US banks. Greek debt is $350 billion, with about $270 billion of that spread among just three European countries and their banks. Make no mistake, a Greek default is another potential credit crisis in the making. As noted above, it is not just the writedown of Greek debt; it is the mark-to-market of other sovereign debt.

That would bankrupt the bulk of the European banking system, which is why it is unlikely to be allowed to happen. Just as the Fed (under Volker!) allowed US banks to mark up Latin American debt that had defaulted to its original loan value (and only slowly did they write it down; it took many years), I think the same thing will happen in Europe. Or the ECB will provide liquidity. Or there may be any of several other measures to keep things moving along. But real mark-to-market? Unlikely. "

So although the Greece bailout, Dubai default, and PIIGS bond auction failures all point to bank losses, a speculator will need to be very careful determining the course of action to protect their financial position.

Friday, February 12, 2010

Short Oil: USD strength will drive oil down

Over the past six months, the leveraged rise of oil prices has been largely been explained by the drop in the USD despite over two years of continuous slide in demand for oil.

Yet over the last two months the USD has started to shoot up and oil has mildly corrected in kind.

... despite reports of excessive inventory. In fact, some traders are still optimistic regarding oil in the face of these bearish indicators.

Marketwatch reports ...

"The Greek bailout is helping support global markets and the price of oil," [Mike Sander, investment adviser at Sander Capital in Seattle] said. "If Greece was leaning further along to a default, then we would have seen oil break $70 for sure."

The inverse relationship between crude prices and the U.S. dollar has decoupled over the past three sessions, which may continue if the stock market stays strong, said Jim Ritterbusch, president of Ritterbusch & Associates, in a note to investors.

A large build in U.S. oil stockpiles may also be overshadowed by developments regarding the European Union's plan to address Greece's debt issues, he said. "We expect wide price swings in both directions going forward as an unusual crosscurrent of financial guidance will occasionally be butting heads with bearish underlying oil fundamentals."

To think that data from three trading sessions identifies the decoupling of a year long trend is a little far fetched.

But as far as the Greece debt bomb destroying the price of oil, I highly doubt Greece will default either. It is not in the interest of anyone with real money that they do default. But as soon as Greece gets their bailout package, the other PIIGS will come to the trough. The question is not if one can be bailed out, but will all of the countries with debt solvency issues be bailed out. This fear will be enough to drive the market to the USD and put longer term pressure on oil.

Even without a crisis in the making, forecasts for oil consumption are not strong. Whether it is demand fundamentals or technical factors, both provide tremendous demand for the USD that makes the price of oil in USD look very expensive.

This disconnect cannot stand. Oil will correct in correspondence with the new demand for the USD.

The author is short oil by going long SCO April $16 calls purchased at $1.40.

[Oil demand chart in the US]

Tuesday, February 9, 2010

Roubini right in long run.... but in the long run...

... were all dead.

Roubini's recent comments that "The USD will devalue by 15% - 20% over the next few years" makes sense, assuming China keeps it's stimulus in place and consequently emerging market commodity providers continue to grow. But in the more visible and short run, the USD looks much more fierce than that long term assessment.

The Greek drama is just the prelude to a string of sovereign financing crisises. The risk premiums will return and the spreads will widen as countries compete with each other for funds to borrow. During these bond auction charades, the US will look safe and secure. Remember, the treasury issued the most debt between the 3yr and 7yr maturities, so the bulk of US massive stimulus funding does not start to come due for a couple more years. Moreover with the unwind of programs for QE using treasuries, mortgage backed securities, asset backed securities, bank debt guarantees, foreclosure moratoriums and whatever else by this March, deflationary forces will come back in force in the US.

So although monetary stimulus has set the stage for inflation when price support is found, the immediate drama in the Eurozone guarantees that the USD will stay strong for a while. In this market, a while is a mighty long time.

Sunday, February 7, 2010

Greek drama

The dramatic events playing out in the press regarding Greek sovereign debt are almost guaranteed to manufacture a happy ending to the final act. But the real outcome will be when the curtains are closed.

It was just a matter of time before all of the global bailouts led sovereign nations to severe debt strains. Unlike the subprime crisis where there was disclosure and mark-to-market accounting for a little while, national fiscal conditions of the PIIGS (Portugal Ireland Italy Greece Spain) are ripe for off balance sheet manipulation. Look at how the US keeps Freddie and Fannie off the official debt tally even though they are now explicitly supported by the US taxpayer.

Moreover, when Iceland's banks were on the brink, the IMF swooped in and recapitalized the country. Who funds the IMF and influences their largesse? The same central bankers (US, Japan, UK, Germany, China) whose banking interests would suffer from any economic shock wave or market turmoil.

"Privately, American officials have said there is next to no chance that Greece will default on its debts. They said European officials were balancing a conviction that the International Monetary Fund should not be involved in solving Greece’s problems with their belief that political pressure was necessary for the Greek political leadership to cut spending and raise revenues."(1)

Greek change of heart? Not even an interesting subplot, Krugman noted that Greece has spent 50 of the last 200 years in default.

But since the issue of sovereign debtors needing forebearence will be a common theme this year, there is lots of interests in not seeming too lenient in the public. Otherwise everyone will want the same sweet deal. Another resolution will be a backdoor bailout by a willing party with an off balance sheet swap deal with funny accounting. If I were to write the script of the conclusion to the third act, it would be "You pay me $100B USD now and I pay you two payments of $75B USD of Yen over the next two years and your government buys only Toyotas for the next ten years." This has been done before.(2)

No matter what monologue of despair or dialogue of conflict plays out in the press, the final act will be a private arrangement where the main actors are major investment banks and quasi government investment vehicles. In fact, Goldman Sachs is at the tip of the spear making sure the conclusion of this drama is a happy one, at least in public. (3)

(1) "Group of 7 Vows to Keep Cash Flowing" New York Times, Feb 6, 2009, by Sewell Chan
(2) "Traders, Guns, and Money", written by Satyajit Das, p. 106-10
(3) "Is Greece’s Debt Trashing the Euro?" New York Times, Feb 6, 2009, by Landon Thomas Jr.

Feb 14, 2009 update

This article confirms my speculation was spot on.

"In Greece, the financial wizardry went even further. In what amounted to a garage sale on a national scale, Greek officials essentially mortgaged the country’s airports and highways to raise much-needed money.
Aeolos, a legal entity created in 2001, helped Greece reduce the debt on its balance sheet that year. As part of the deal, Greece got cash upfront in return for pledging future landing fees at the country’s airports. A similar deal in 2000 called Ariadne devoured the revenue that the government collected from its national lottery. Greece, however, classified those transactions as sales, not loans, despite doubts by many critics."

After this initial deception to get into the euro... there was even more deception to stay in the euro...

"The answer was no. But in 2002, accounting disclosure was required for many entities like Aeolos and Ariadne that did not appear on nations’ balance sheets, prompting governments to restate such deals as loans rather than sales.
Still, as recently as 2008, Eurostat, the European Union’s statistics agency, reported that “in a number of instances, the observed securitization operations seem to have been purportedly designed to achieve a given accounting result, irrespective of the economic merit of the operation.”
While such accounting gimmicks may be beneficial in the short run, over time they can prove disastrous.
George Alogoskoufis, who became Greece’s finance minister in a political party shift after the Goldman deal, criticized the transaction in the Parliament in 2005. The deal, Mr. Alogoskoufis argued, would saddle the government with big payments to Goldman until 2019.
Mr. Alogoskoufis, who stepped down a year ago, said in an e-mail message last week that Goldman later agreed to reconfigure the deal “to restore its good will with the republic.” He said the new design was better for Greece than the old one.
In 2005, Goldman sold the interest rate swap to the National Bank of Greece, the country’s largest bank, according to two people briefed on the transaction.
In 2008, Goldman helped the bank put the swap into a legal entity called Titlos. But the bank retained the bonds that Titlos issued, according to Dealogic, a financial research firm, for use as collateral to borrow even more from the European Central Bank.
Edward Manchester, a senior vice president at the Moody’s credit rating agency, said the deal would ultimately be a money-loser for Greece because of its long-term payment obligations.
Referring to the Titlos swap with the government of Greece, he said: “This swap is always going to be unprofitable for the Greek government.”"

Tuesday, January 26, 2010

CEG: Credit Crisis Survivor on the Rebound

Constellation Energy - a company with $21B in sales and $7B market cap. Credit crisis survivor. This company was caught in a debt trap with the bankruptcy of Lehman at height of the credit crisis. CEG made it through as an independent company, but have they solved the problem?

With the completion of the $4.5B sale of 50% of their nuclear energy business to EDF, the company is now on solid footing. This raised $2B in cash to the balance sheet. The company also moved ahead with debt reduction starting with a $1B payoff of debt due in 2012.

But is the company still exposed to another cash shortfall? There are two areas of concern 1) derivatives and 2) debt.

Derivative exposure is still at $1B. Worst case scenario, they use their new cash balance to handle any problems. (CEG 3Q 2009 10-Q)

What about their debt schedule (including BGE)?

Not bad.

Although current earnings are neglible due to deleveraging, this is a temporary circumstance. Overall, earnings should return to $200m per quarter over the next year due to the rebound in energy prices and the economy. This is modest compared to the previous track record which recorded close to $700m+ in earnings per year throughout the last decade.

Bottom Line: CEG looks like it has eliminated it's debt problem has tremondous earnings upside to drive value for investors.

The author is long CEG.

Thursday, January 21, 2010

Stimulus Watch: China keeps throwing out the dough

Apparently China is making a mild attempt to preempt a credit crisis in China...

"Premier Wen Jiabao said yesterday China will “well manage” the pace of credit growth after a record 9.59 trillion yuan of new loans were doled out in 2009, stoking concerns of asset bubbles and worsening credit quality. China’s central bank last week raised the proportion of deposits banks must set aside as reserves for the first time in 18 months."

Lending 9.59 trillion yuan is lending over 25% of GDP in one year. Let's see what they plan for next year...

"China has told some banks to limit lending and will restrict overall credit growth in the nation to 7.5 trillion yuan ($1.1 trillion) this year, banking regulator Liu Mingkang said."

This amount is still over 20% of GDP of nominal loans in one year. Wow.

In addition, the fiscal stimulus keeps rolling...

"...the 4 trillion renminbi multiyear fiscal package, which was announced last year, which is equivalent to 15% to 20% of GDP. ...It's a massive undertaking, all funded internally by the Chinese government plus some private equity participation."

I am not sure when China's fiscal stimulus effect is expected to peak. If someone has found a reference, let me know.

Overall, should you go long China? Can't say. Looks tempting. Despite the huge run up already, i will look into opportunities.

Wednesday, January 13, 2010

Stimulus Watch: Not more bad is good

Over the next few months, the receding stimulus will have a negative effect. But what has it done thus far?

According to the rail car stats, nothing but stabilize the situation.

But looking at a bigger picture, things have been less worse.

Understanding what this will mean in the next few quarters is "above my pay grade".

This blog will continue to look for opportunities, long or short, wherever they arise.

Tuesday, January 12, 2010

GMK: Value south of the border

Is there a more stable business than having the #1 torilla brand in Mexico?

Has $3B USD in sales and is a market leader in the US, Mexico and a few other countries. They saw a 1% increase in revenue this year (excluding currency issues). Operating margin for the business increased in 2009 to 6.3% from 4.6% last year. Operating profits totaled close to $100m USD for 2009. YAWNN!!!!! Are you bored yet? Let's get to the real questions.

A year ago GMK was caught in a horrible hedging position as corn prices collapsed that caused an $800M+ USD loss for 2008. The GMK was saved by banks (most likely the same banks that sold them the derivatives) and now is liable for a $660m USD note which comes due in 2014. So why invest? Value.

The current market capitalization for GMK is $1B. At the current amortization rate (and assuming they once again refinance to a yet smaller debt position again in 2014) the company should still hold at least a $1.5B market cap. The credit crisis may not be over, but viable businesses like GMK are not likely to remain exposed in the same way as pre-2008. Let's take advantage of this painfully gained wisdom and buy GMK.

The author recommends buying at $8.50.

IMAX changed the movie business

Did you see Avatar? Everyone did. But did you see Avatar on 3-D IMAX? If so, then you really saw Avatar. The game has changed. Catch the ride.

3-D and IMAX have not only changed the future of the movie business. They have changed the business model of the movie business. IMAX used to be just science documentaries at your local museum. IMAX has made deals with all but one of the major studios to collect 1/3 of the box office take for any feature shown in their theatres. To see Avatar costs $10.50 for a regular adult ticket, but $16.50 for the IMAX experience. Just Avatar alone will put them in the black for 2009.

But the 2010 line up is just as impressive...Alice in Wonderland, Shrek, How to Train Your Dragon, Toy Story 3, and Twilight:Eclipse. It will be a while before a movie like Avatar invests as much in cutting edge graphics. But, as James Cameron has noted, the platform is now there.

"The box office success of “Avatar” boosted analyst estimates for Imax Corp.’s fourth-quarter EBITDA estimate to $20.3 million from $13.7 million and earnings per share to 15 cents from five cents. [EBITDA or earnings before interest, taxes, depreciation and amortization, is a key measure of operating cash flow.] The Firm says IMAX’s share of the box office has risen to the 15%-18% range from the typical 8%-12% from just 3%-4% of the screens, showing the format is a “must-have” for multiplex operators."

International growth is also being initiated due to brand recognition and word of mouth about the IMAX experience. The game has changed worldwide, if an action movie is a must see, then it must be seen on IMAX.

The author recommends buying IMAX at $13.10.

Saturday, January 2, 2010

Buy a Warren Buffett throwaway: Constellation Energy

Constellation Energy is an energy trading holding company with a large regulated utility, Baltimore Gas & Electric, as a subsidiary. In late 2008, the bankruptcy of Lehman Bros caused a massive liquidity crunch for Constellation Energy holding company. The ensuing capital crunch for their positions led them to seek Warren Buffett to provide the capital to allow the holding comapany to stay out of bankruptcy. Warren the White Knight, after staving off creditors sold his position and for his charity received break up fee of $1B from Constellation Energy.

The story was not over. With it's credit rating shot because of the trading mishap, Constellation Energy still needed to secure greater financing. Since the credit markets were closed to risky investments, the company sold half of it's assets to EDF, the French state owned electric utility for $4.5B. The story was still a nail biter because there was political pressure in France not to do the deal. For Constellation Energy, this was a quick end to their liquidity issues or possibly another capital crisis if the deal fell through. On Nov 6th, the deal completed and now CEG is on stable ground.

Reviewing their 3rd quarter statement, the Constellation Energy holding company still holds over $1B in energy trading instrument exposure.

So why touch this dog with bad management? Purely on value. Constellation Energy is a company with annual sales of $19B for 2008 (expected at $16B in 2009) with a market cap of $7B. Now that the EDF joint venture is closed, bankruptcy is absolutely off the table. The company turned profitable again in the 3rd quarter of 2009. Is it sustainable? I don't know. But even if the company breaks even, it is a steal.

Just two years ago, this stock was $60 and had a 3% yield.

I am buying CEG at market. On Jan 4th and it will be the first thing I do in the new year.

Even better than the common shares are the subordinated debt of the Baltimore Gas & Electric (BGE) subsidiary. Thus far, all the problems with CEG have come from the energy trading holding company, the regulated utility has been uneffected other than the fact that they have leaned on the subsidiary for capital during the capital crisis.

As a measure for closing the sale to EDF, CEG committed to recapitalizing BGE.

"The PSC ruled Oct. 30 that Baltimore-based Constellation (NYSE: CEG) could go forward with the EDF deal if it included a handful of concessions. They included:


• A $250 million investment into BGE; and,

• A restriction from drawing dividends from BGE if it would drop the utility’s cash reserves below a certain level."

Thus I am also recommending again BGE Capital Trust II (NYSE:BGE-PB). The subordinated debt has a 7.5% yield and is selling 10% below par.