Macro Tsimmis

intelligently hedged investment

Archive for September, 2008

BUY TO COVER Wachovia (WB)

Posted by intelledgement on Mon, 29 Sep 08


Amid the sturm and drang of the bailout vote and the market crash after the U.S. House decided “no,” an important subplot today was the demise of Wachovia (WB), the fourth-largest USA bank, shares of whom we have been short intermittently since last November.

Although WB stock traded as high as $24/share intraday just ten days ago on misplaced optimism, it became evident over the weekend that the weight of the toxic paper WB acquired when they purchased Golden West two years ago—compounded by bad loans and other inauspicious financial transactions the company made on their own—were dragging Wachovia into insolvency. Following emergency weekend negotiations, Wachovia issued a joint announcement with Citibank (C) this morning detailing an agreement for C to purchase WB’s retail bank, corporate and investment bank, and wealth management businesses for $2.1B.

As part of the transaction, Citibank will assume Wachovia’s $53B in senior and subordinated debt. Citi will acquire more than $700B of assets of Wachovia’s banking subsidiaries, and related liabilities. The catalyst for the deal is a government guarantee (reportedly U.S. Treasury officials inveigled Citibank to participate in the negotiations). The Federal Deposit Insurance Corporation (FDIC) has agreed to provide loss protection in connection with approximately $312B of mortgage-related and other Wachovia assets. Citibank is responsible for the first $42B in losses; the U.S. Treasury is responsible for anything beyond that. U.S. taxpayers get $12B in preferred stock.

WB will be left with their minor player brokerage business and their Evergreen Asset Management subsidiary. The deal was announced just before the market opened  and it was unclear how investors would value the remaining Wachovia entity. The stock opened at $1.26—down from the $10 close last Friday—and rose as high as $5 before crashing down with the rest of the market following the failed bailout vote, sinking as low as one cent(!!) before settling at $1.84.

Wish we had been nimble enough to score that one cent price, but with the effective demise of Wachovia here, there’s no reason to maintain this short position, and we are putting in a buy-to-cover limit order for tomorrow at $3.68 (twice today’s close). This will result in us covering our short position if WB opens at or below $3.68 tomorrow. If it opens higher, then we will still cover if it trades at or below $3.68 during the day tomorrow. If our position is still open after trading closes tomorrow, then we will reconsider what to do after the close.

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Beazer Homes (BZH) update #12

Posted by intelledgement on Sun, 28 Sep 08

Given the current financial tsunami, you have to work really hard to find any good news for a homebuilder. But Beazer Homes (BZH)—shares of which we have sold short in the expectation that the company is in for extremely tough times and may not survive—generated a genuine candle in the dark this week with the announcement that they have reached a settlement with the SEC. BZH were being investigated for possible fraud, internal control failures, and reporting violations, but under the settlement announced Wednesday, the company “consented, without admitting or denying any wrongdoing, to a cease and desist order requiring future compliance with certain provisions of the federal securities laws and regulations. The settlement does not require the Company to pay a monetary penalty and concludes the SEC’s investigation into these matters with respect to the Company. In the order, the SEC stated that in determining to accept the settlement, it considered both remediation efforts undertaken by and cooperation from the Company,” according to the press release.

We still think Beazer’s prospects are dicey here—aside from the terrible underlying business climate, they still face an ongoing DOJ criminal investigation relating to the way they treated their customers prior to 2007—but kudos to the new management team for working hard to clean up the mess and committing to do business on an ethical basis going forward. While we believe BZH stock is still overvalued here at $6.18—up 5% since this settlement was announced—if the company does survive, shareholders will have their new management to thank.

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Vertex (VRTX) update #17

Posted by intelledgement on Wed, 24 Sep 08

Vertex (VRTX) stock rocketed up 16% today after the company released new data on their ongoing phase 2 trials of their anti-hepatitis C drug candidate, telaprevir. According to published reports, the data indicated that a two-dose-per-day regimen of telaprevir was just as effective as the three-dose-per-day regimen (at a lower dosage) that had been exclusively used up to now.

This is important for two reasons: [a] it is easier for patients to take a drug twice a day than three times a day and [b] some prospective competitors to telaprevir are designed for twice- or once-a-day dosing, which in the event any of them prove as effective, would have given that drug a big advantage if telaprevir required thrice-a-day dosing.

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Vertex (VRTX) update #16

Posted by intelledgement on Mon, 22 Sep 08

Our development-stage biotech is replenishing the war chest with a dilutive issue of 8.6MM shares of common, priced at $25.50. The issue is in line with our expectations (we had projected dilution of about 7.2MM shares this year—a 5% dilution—in our model). The market apparently agrees, as the stock closed today down just 1.7% from the close on 16 Sep, the day before this sale was announced.

We expect the company will continue to need funding for the expensive telaprevir trials currently underway through mid-2011, and that more dilutive stock issues are likely.

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Goldman Sachs (GS) update—now a bank holding company

Posted by intelledgement on Mon, 22 Sep 08

In case anyone had any remaining doubts about our short sale of Goldman Sachs (GS) shares, that would have been assuaged Sunday, night, when the Federal Reserve made the surprise announcement that the investment banks Goldman and Morgan Stanley (MS) had applied for and been granted bank holding company status. This means that the banks will be able to borrow money from the Fed at the same favorable rates that apply to the likes of Wachovia (WB), Bank of America (BAC), HSBC Holdings (HBC)—all of which we are also short—and other bank holding companies.

In effect, the government is—once again—acting to prop up institutions that have gotten themselves into deep water and are in danger of being swamped. We decry this policy, partly because it tends to prop up the share prices of companies we are short (at least, in theory…in practice, GS shares were down 7% today and BAC, WB, and HBC all declined as well) but mostly because it is a bad policy that wastes public resources to bail out companies that have behaved both stupidly and contrary to the public good and should therefore be allowed to lie in the beds of their own making, be those coffins or whatever. However, we take some solace in the affirmation from those in a better position to know than we are that things at Goldman Sachs are really, really bad.

And note to ourselves: consider shorting Morgan Stanley when the short ban ends on 2 October.

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Bank of America (BAC) update #2—SEC Halts Short Selling of Financial Stocks

Posted by intelledgement on Sun, 21 Sep 08

Wow, what a difference a week makes.

Bank of America (BAC) shares closed at $37.48 Friday, up 23% on the day and up 50% from Tuesday’s $25 close. The surge is attributable to optimism that the government’s plant to create a fund to purchase toxic assets will be approved by Congress and save the bacon of the (probably) insolvent banks combined with the effects of the SEC’s announcement on Friday that short-selling of financial company stocks has been banned through 2 October on an emergency basis. And indeed, we are now under water on two of our four bank shorts (BAC and HBSC Holdings), and even Goldman Sachs (GS) and Wachovia (WB) were up sharply although we are still ahead on those two.

While we are now ruing our decision not to cover our Bank of America short on Monday (when we were 23% ahead), it is leavened with the realization that while today would have been a great opportunity to resume the position, we would not have been allowed to. (We are allowed to maintain our previously existing positions, however.) We think the proposed government plan to, in effect, bail out the banks for bad management with taxpayer money by buying their worthless toxic assets is a terrible idea. These companies irrationally bet that real estate prices would go up forever and the way capitalism is supposed to work is that when you screw up, you suffer the consequences. Bailing these companies out with taxpayer money would reward failure, keep broken institutions in business that we’d be better off without, and deepen the financial hole the government itself is in.

We hope that the plan is rejected by Congress, but even if it is not, we don’t believe it will work to prop up the value of these failed companies. There is no way the government can afford to purchase all the toxic assets out there unless they are valued at a steep discount, and doing that probably will cause many financial institutions to skirt dangerously close to insolvency (as opposed to holding onto the assets marked at book value in the hope that they will eventually recover value, or else that the overall financial condition of the institution in question will improve enough to render the issue of the valuation of the assets a noncritical issue).

As for the ban on short selling, it reflects the SEC’s agreement with our thesis that [a] the level of systemic risk here is high and [b] in the shadow of potentially high risks, valuations for those financial firms under pressure are likely to gyrate wildly (as we have recently seen in the cases of Bear Stearns, Merrill Lynch, Lehman Brothers, and AIG…if we had been really smart, we would have been short all those companies!).

So for now, in the knowledge they are irreplaceable and the expectation they will still payoff big, we are holding firm on all four of these short positions.

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BUY Cabela’s (CAB)—“World’s Foremost Outfitter”

Posted by intelledgement on Fri, 19 Sep 08

OK, OK…yes, yes we just shorted a bunch of retailers earlier today. Banks are on thin ice, credit has dried up, real estate is crashing, gold is soaring, the chairman of the Fed and treasury secretary are begging Congress for $700 billion of taxpayer money to bail out the insolvent financial sector, the economy is tanking, consumer spending is drying up…so why are we buying a retailer here?!?

Well, for one thing, Cabela’s—the “world’s foremost outfitter”—is not just any retailer. They are focused on a segment that we expect to remain strong even as the US economy overall suffers: hunting, fishing, camping, and related outdoor merchandise. Secondly, while they have been expanding their network of stores (28 in the USA and one in Canada) rapidly—they increased their square footage 49% in 2007 and opened two more stores this year—their roots are in direct marketing, and it still accounts for about half the company’s revenue. The founders, Dick and Mary Cabela, ran the initial direct mail operation from their kitchen from 1961 to 1964, moving to the basement of Dick’s father’s furniture store in their hometown of Chappell, Nebraska when they needed warehouse space. By 1969, they had expanded to a combined 50,000-ft. warehouse/store in nearby Sidney. Over the decades, revenues from retail operations grew from 0% to 50%, but they still publish nearly 100 catalogs a year…and their direct marketing roots enabled them to make a seamless transition to the internet starting back in 1998. Check out their first-class website.

Not to say that Cabela’s have been unaffected by the current economic travails. They have slowed their expansion plans—originally they intended to open four stores this year—and have had to scramble a bit to keep their financing in order. Their debt has ballooned from $200 million when they went public four years ago to $800 million as of 2Q08, and their profit margins have thinned. Never-the-less, they have increased their year-over-year revenues and turned a profit every single quarter—17 in a row and counting—since the IPO in June 2004. But a receding tide lowers all boats and the stock—which was valued at $20 at the IPO—is down some 40% from where it was a year ago ($25.03 on 19 Sep 07).

Arguably, even if cheap compared to past levels, this is not an optimal time to buy CAB with the economy clearly under pressure here. There is panic in the air and the stock could easily plummet (along with everything else) to bargain-basement levels. But we have two compelling reasons to buy CAB, one tactical and one strategic. The tactical reason is that we are selling short three retailing-related companies today and buying CAB—whom we believe to be in a stronger position than any of the others—serves as a hedge to limit the damage just in case we are wrong. The strategic reason is the one we already mentioned: if things do get rough, we expect that a company selling guns and fishing rods and stuff you can use to “camp out” if needed will do exceedingly well. While not directly targeting the survivalist market, Cabela’s offers a lot of the basic necessities at great prices.

What will most probably happen is that the stock of all four retailing-related stocks will go down, and if we time it right, we will cover our shorts near the bottom (and maybe buy some more CAB!) and then (subsequently) profit on this speculation, too.

Or worst case if things get really bad, hopefully being a Cabella’s shareholder will count for something if and when ammunition gets scarce and we go to one of their stores to restock our cache.  🙂

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SELL SHORT Best Buy (BBY), Mastercard (MA), & Wal-Mart (WMT)

Posted by intelledgement on Fri, 19 Sep 08

We detailed the reasons why we think it is prudent to short retailers earlier today in our IMSIP post recommending purchasing inverse consumer goods and services ETFs. Accordingly, in the ISOP, we are selling short retailer giant Wal-Mart (WMT), specialty retailer Best Buy (BBY), and consumer credit card vendor Mastercard (MA). Given the weakness in consumer spending that we anticipate over the next 12-to-18 months, we anticipate that all these companies are likely to experienced both sales and profits that are below both prior performance and expectations. And, of course, that this will adversely affect the price of their stock.

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BUY UltraShort Consumer Services/Goods ETFs (SCC/SZK)

Posted by intelledgement on Fri, 19 Sep 08

The DOW soared 400 points yesterday—and is up again in early trading today—on reports that US Treasury Secretary Henry Paulson is shopping a plan to members of Congress that would fund the purchase of “toxic” securities held by banks and other financial institutions by the US government to get them off the balance sheets of the banks and thus hopefully render those institutions credit-worth again. There is a lot of uncertainty here: we have no idea precisely how the plan would work, when or even whether it will be adopted, and only the vaguest notion of who would be included (what about foreign-based financial institutions who have US mortgage-backed securities fouling up their balance sheets?).

However, we can say with utter confidence that the fact this plan is being proposed is not a good reason for stocks to be going up here. Manifestly, Paulson and Ben Bernanke have concluded that the bursting of the housing price bubble has at last spread to the rest of the US economy, in the form of tighter credit. To us this sounds like the final nail in the coffin of consumer spending, which means we are in for at least 12-to-18 months of pain…and it could be worse. This plan to loosen credit—by improving the balance sheets of the financial institutions thus making it easier for them to both lend and borrow—does almost nothing to address the underlying problem of falling real estate values. In effect, it treats a symptom of the disease, which may or may not make our convalescence less painful, but the disease must still run its course.

Consequently, we are persuaded that the time is ripe to short the consumer sector of the US economy. Until now, we have considered that a meltdown of the market was most likely to occur after the US presidential election, but the odds for it to happen sooner have risen appreciably here. Paulson and Bernanke are wielding baling wire and spirit gum and there was never a question about whether or not those tools were adequate to keep the wings of the economy from being blown off—they are not—but only when the winds of the coming storm would rise to the danger level. It is happening sooner rather than later.

The Ultrashort Consumer Services ETF (SCC) is an almost pure reflection of the US consumer sector; the Ultrashort Consumer Goods ETF (SZK) does include some exports, but we anticipate the effects of this consumer slowdown to be felt globally, so we are buying both here. The SCC is designed to rise or fall 2% inversely for every 1% move in the Dow Jones U.S. Consumer Services Index, which is primarily comprised of retail, media, and travel and leisure sectors…hotel, car rental, airline and cruise line companies. The SZK is designed to rise or fall 2% inversely for every 1% move in the Dow Jones U.S. Consumer Goods Index, which primarily includes companies that manufacture consumer products. Managers for both funds aim to achieve their goals by selling short equities and trading futures, options on futures, swap agreements, forward contracts, and options on individual securities or indices.

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Bank of America (BAC) update

Posted by intelledgement on Mon, 15 Sep 08

We are short shares of Bank of America (BAC) and today we got an incredible gift—the company announced that they will be buying Merrill Lynch (MER) for $50 billion. This shotgun wedding—evidently encouraged by the Feds who had originally hoped either MER or BAC could be persuaded to purchase Lehman Brothers (LEH), and thus cover that firm’s losses (Lehman Brothers announced they were going bankrupt today)—is essentially a rescue of Merrill Lynch, which were threatened with insolvency due to losses related to credit default swaps they had created and damage from the LEH failure.

We consider the fact that BAC management are purchasing MER with so little due diligence to be recklessly imprudent. And we consider the fact that they are paying $29/share after MER stock closed Friday at $17.05—and is arguably worth much, much less—to be dazzlingly stupid. And the market overwhelmingly agrees with us, as today BAC—on all-time high volume of 276 million shares—closed at $26.55, down 21% from last Friday.

We should probably cover here, with a one-week profit of 23%, but we are very confident that worse is yet to come for BAC.

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