The Limerick of Finance for 02/28/10

The pace of buyouts is increasing
Multiple synergies they're releasing
They'll close a big deal
Then it's time to get real
Fire some people with cost-cutter squeezing

Buyout Action To Kickoff March '10

Two probable merger deals I'll be watching this week . . .

Coca-Cola (KO) is buying one of its distributors, Coca-Cola Enterprises (CCE). Coke's betting on vertical integration. This is a complicated transaction and not a complete merger.

Merck (MRK) is buying Millipore (MIL) in an all-cash deal to branch out into broader life science type stuff.

I'm no specialist in either retail beverages or pharmaceuticals, so anything I have to say about either deal will treat them as short term special situations. The MRK-MIL deal looks more appealing since it's all cash.

You Tell 'Em, Warren

Warren Buffet once again hands the world some common sense. Unfortunately it's no longer common:

Buffett used most of his letter, released Saturday, to reiterate the business basics that have made his company a juggernaut. But it did include a section about how corporations should manage risk. Buffett said CEOs and the boards that hired them should pay a steep price if their companies get into trouble with risky investments.

Buffett lamented that shareholders, not CEOs and directors, have borne most of the burden of company failures during the economic crisis.

He's describing what's known in academic circles as the agency problem. Agency problems are now a permanent fixture of corporate governance because a hereditary class of perpetual Peter Principle executives has captured boards of directors. Why do people join boards anyway? Ostensibly they should enjoy working for shareholders and helping CEOs fix problems. I suspect they just want the prestige value of board membership for networking and resume padding.

Grow some spine, board members. Put me on a board and watch sparks fly as I insult some Harvard MBA CEO for buying a private jet. Then watch me get voted off the board for making waves. Wheeee! Business is fun.

The Haiku of Finance for 02/26/10

Home sales declining
Good luck trying to sell one
Just cut the price down

Homes Sales Flushed, Fannie Floundering

Did my headline grab your attention? That was my intent. If that didn't work, perhaps this article will grab you:

Sales of previously owned U.S. homes unexpectedly dropped 7.2 percent in January to a seven-month low, indicating a lack of job growth is undermining government incentives to bolster the housing market.

Lack of sales will surely force existing sellers to drop their asking prices, further sinking home values in your neighborhood. This will put more homeowners underwater on their mortgages and force more foreclosures. The vicious cycle will soon pick up speed, and yet another sign is the Fannie monster's continuing hunger for bailouts:

Fannie Mae, the mortgage-finance company under federal conservatorship, said it will seek $15.3 billion in aid from the U.S. Treasury after posting a 10th straight quarterly loss.

The U.S. economy is not in recovery because mortgage-related debt has not been flushed into default. We've probably just crossed through the eye of the hurricane and are about to be hit by the next wave of the storm. The trouble with this hurricane is that poor public policy will prolong its duration. Batten down your hatches.

California Busting Bonds

California is the Golden State. Its credit rating, unfortunately, is not so golden. Its general obligation bond rating is the lowest in the nation and has shown a steady deterioration throughout 2009. How did this happen? A recent article outlines the unfolding tragedy:

Federal law prohibits states from declaring bankruptcy and without a legal framework, assertions about California's solvency are left to interpretation. But persistent multibillion-dollar budget deficits, cash crises, tens of billions of dollars in debt and other obligations have blurred the legal distinction.
(snip)

Over the next 16 months, the state has a $20 billion deficit in the general fund budget. That's the equivalent of nearly a quarter of the current spending plan of $84.5 billion. Much of that spending is locked in because of voter initiatives and federal mandates, limiting options for lawmakers. The deficit this year is more than the state spends on higher education and prisons combined.

The state's pension fund, CalPERS, has $16.3 billion more in liabilities than assets at the latest calculation, although that number fluctuates with the system's investment portfolio. Adding to that, a state report released this month calculated that California also faces a $51.8 billion bill - in 2009 dollars - for the health and dental benefits of state retirees and future retirees.

The Governator's plan to balance his state's budget in 2010 relies heavily on a federal subsidy of $6.9B. There is no assurance that this subsidy will be forthcoming in an era when one of every three dollars in federal spending is itself borrowed from the bond market. Note further that the non-partisan Legislative Analysts's Office has published a pessimistic analysis of proposals to reduce the state budget deficit. The LAO assesses a significant part of the Governator's "trigger proposal" estimate to be unreconcilable; it further assesses many business subsidies and tax exemptions as ineffective and unjustifiable. This sets the stage for further political wrangling and puts the passage of a balanced budget for 2010-11 at risk.

The excerpted article above notes further down that the state's net assets exceed its net liabilities by $34B. If the state is unable to resolve its budget crisis, would it sell state parks and government buildings to pay its bills? The Governator floated just such a trial balloon last year, probably as a political ploy to force a budget solution. A budget crisis this year may see such proposals become reality.

The risk to California muni bond investors from prolonged budget inaction is significant. In addition to individual and pension plan holdings of Cal munis, three ETFs hold state bonds - PowerShares Insured California Muni Bond (PWZ), SPDR Barclays Capital California Muni Bond (CXA), and iShares S&P California Muni Bond (CMF). The ETFs hold about $290mm worth of munis, all with medium to high interest rate sensitivity. Any further downgrades to California's credit rating will raise the state's borrowing costs, posing an immediate risk to holders of those ETFs.

Nota bene: Anthony J. Alfidi does not own any California muni bonds or any of the ETFs mentioned in this post. He is a resident of San Francisco, California and thus a state taxpayer.

Smith International Has Few Alternatives To Schlumberger

Boards of publicly held companies have a duty to maximize shareholder value. Attorneys are wondering whether the board of Smith International (SII) has done all it can:

The investigation concerns whether the Smith Board of Directors breached their fiduciary duties to Smith stockholders by failing to adequately shop Smith before entering into the merger agreement, and whether Schlumberger is underpaying for Smith shares, thus harming Smith stockholders.

The first question is easier to answer than the second. Baker Hughes (BHI), a major competitor, is preoccupied with its acquisition of BJ Services (BJS) and would be hard pressed to make a competing bid for SII. Halliburton (HAL) has a much larger market capitalization than SII and could presumably make a stock offer that has less of a dilutive effect than Schlumberger's (SLB) offer. However, HAL seems to be more focused on pursuing organic growth rather than acquisitive growth as a strategy. It is thus easy to give SII the benefit of the doubt for taking SLB's offer.

The second question of whether the offer represents best value is more difficult to assess. SII's P/E ratio is currently over 61, pricing this company at a massive premium relative to its peers. SII shareholders should be impressed that the market is valuing its prospects as if it were a growth company rather than a seasoned producer in a mature industry. SLB is arguably paying a huge premium for SII's topline revenue, betting that its decline in revenue last year is temporary and can be ameliorated in a combination. Failure to complete this bid would relegate SII to competing against three super-large competitors with stronger balance sheets and operating margins. Only a surprise offer from another firm can definitively prove that SLB's offer for SII is too cheap.

Nota bene; Anthony J. Alfidi is short puts under SII at the time this post was published. He has no position in any other stock mentioned in this post.

Updating The Alpha-D For Feb. 2010

Here are the positions I've refreshed (due to options expirations) . . .

Short straddles on GDX and FXI. These are very long term holdings and I continue to use them to generate cash flow. I also write covered calls on GDX in my IRA.

Short puts under TDW at 40. I like Tidewater and I'm willing to buy at 40. I wouldn't mind being forced to do so when the second phase of the credit crunch roils the markets. TDW will be a long term holding if and when I ever go long.

Here are new positions . . .

Sold covered calls on ANV at 15. Allied Nevada has done very well for me, and I wouldn't mind it if my position is sold away should me covered calls be exercised at 15.

Sold short puts under SII at 37. This is a special situation presented by Schlumberger's buyout of Smith International. I sold puts at 37 to expire in March 2010 to get some quick cash.

Here are existing positions that haven't changed (mainly options awaiting expiration) . . .

Long COMS as special situation, awaiting closure of transaction. Short puts under KEX, willing to go long KEX at some point. Short puts under EFA (awaiting expiration). Long puts against IYR and LMT as bets against new bubbles in real estate and defense spending.

BTW, my puts under Burlington Northern have expired well in advance of their original expiration date. That special situation trade did quite well for me. Props to Warren Buffet for allowing me the opportunity.

First Dubai, Now Kuwait

There is probably no country on earth that can insulate itself from the next phase of the credit crunch. Witness the case of Kuwait, in Kuwaiti bankers' own words:

Most of Kuwait’s multibillion-dollar investment company industry could be wiped out by debt repayments on the finance houses’ leveraged investments made before the recession, senior bankers have warned.
(snip)

While bankers said the investment company woes were largely contained in Kuwait and should not spread, they could lead to distressed sales of overseas assets and were weighing on the exposed local banking sector.

I love the mention of "distressed sales of overseas assets." Take a guess where those assets are located. If you have trouble, just look out your window at the nearest shuttered shopping mall. While you're at it, let your neighbors know that they should slash the asking prices for their homes right now if they want any hope of selling. That's the only way they'll get ahead of the coming CRE debt crash.

These observations are tantamount to an admission that Middle Eastern sovereign wealth funds will be too preoccupied with their own solvency problems to fund any more debt-fueled stimulus in the Anglo-West. The U.S. can forget about a second fiscal stimulus. I blogged about all of this in 2009. Nobody listened to me and that's okay. My historical record is there for anyone to search.

That cloud you see on the horizon is a swarm of Black Swans. You do see it, don't you?

The Limerick of Finance for 02/20/10

Promising no more hikes is inane
Interest rates are too low to maintain
They can't always stay low
Investors ought to know
That's why stocks have continued to gain

Roubini Was Right About The Dollar Carry Trade

Remember last year when Dr. Nouriel Roubini said that any sudden rise in the U.S. dollar's value would put risky assets in a world of hurt? That world is starting to dawn on us:

The dollar posted its sixth straight weekly gain against the euro, the longest streak since 2000, as investors speculated on when the Federal Reserve would withdraw monetary stimulus after it raised the discount rate on Feb. 18.

See what happens when you keep interest rates artificially low just to artificially stimulate the economy? Stock prices become artificially high and you end up living in a world full of artifice.

We're entering a very difficult period for U.S. stocks, IMHO. Anybody who goes long stocks right now without doing serious fundamental analysis will probably be kicking themselves for many years.

The Haiku of Finance for 02/18/10

Fed launches exit
Raises discount rate for banks
Tightening begins

Holy Stagflation, Batman!

Kiss your recovery goodbye. Stagflation is here:

The number of U.S. workers filing new applications for unemployment insurance
unexpectedly surged last week, while producer prices increased sharply in
January, raising potential hurdles for the economy's recovery.

The Great Recession just got a lot greater. Anybody out there willing to go long stocks now? Anybody? (Deafening silence follows.)

General Growth Properties: A Special Situation

Real estate analysts have argued recently that 2010 will prove to be the "year of foreclosures" with an onslaught of bankrupt commercial and residential property coming to market. Simon Property (SPG) smells blood in the water and is making a bid for a troubled competitor, General Growth Properties (GGWPQ.PK):

Simon Property Group Inc., the nation's largest shopping mall owner, made a $10 billion hostile bid Tuesday to acquire ailing rival General Growth Properties.

The acquisition would allow General Growth, the No. 2 owner of shopping centers, to emerge from Chapter 11 bankruptcy protection. General Growth filed for bankruptcy last year after buckling under the weight of billions in debt it racked up during a massive expansion effort fueled by cheap credit.

It's a cash and stock hostile bid. Simon Property's balance sheet seems to be strong enough to handle both this purchase and its pending bid for some assets from Prime Outlets Acquisition Co. If the offer as currently structured gives General Growth's shareholders $6 in cash and $3 in assets per share, the simple math argues for a fair value of $9/share. The market has bid this up to $12, incorporating both the full enterprise value of General Growth (including the $7B going to its creditors) and the possibility that Simon may sweeten the offer now that General Growth has rejected the initial offer.

It is noteworthy that the $3/share asset offer amounts to a total value of over $900mm given General Growth's outstanding shares of 312mm. Simon's shareholders would thus experience a dilution of about 4.2% given its present market cap. That's not so bad if Simon can translate the deal into higher rents from combining anchor properties. Success would mean Simon gains enough earning power to arrest the slide of its retained earnings into negative territory, even if it has to lever up slightly to make this bid more attractive.

Nota bene: Anthony J. Alfidi holds no direct position in either SPG or GGWPQ.PK at this time. He is long puts on IYR as a bearish bet against the entire real estate sector; IYR has a long position in SPG.

Battle Over Greek Debt

In keeping with the theme of hollow states, check out how the EU - a transnational actor primarily staffed by elites - is reacting to Greece's hollowing out:

Greece turned to Goldman Sachs Group Inc. in 2002, just after adopting the euro, to get $1 billion in funding through a swap on $10 billion of debt, Christoforos Sardelis, head of Greece’s Public Debt Management Agency at the time, said in an interview last week. Eurostat, the EU’s statistics office, was aware of the plan, he said. Risk Magazine also reported on the swap in July 2003.

“Eurostat was not until recently aware of this alleged currency swap transaction made by Greece,” spokesman Johan Wullt said by e-mail yesterday.

How about that. The issuance of sovereign debt is theoretically something democratic leaders are supposed to debate in public. This controversy is more than the result of bond market vigilantes at work (we can see their handiwork as bond issuers get nervous about the ability of the market to handle more sales). Debt is now a football tossed around among transnational actors, in this case the EU's unelected bureaucrats and Goldman Sachs' unelected bankers and arbitrageurs.

One scholar in the article above calls for Greece's expulsion from the EU. This cry may rise to a cacophony in the coming weeks as Greece finds that its problems (like an epidemic of tax dodgers sapping its state revenue) aren't amenable to EU-friendly solutions. The pending defaults of other PIIGS nations will weaken the euro further.

Nota bene: Anthony J. Alfidi is short puts under EFA because he wouldn't mind buying into the Eurozone at much lower prices.

The Haiku of Finance for 02/14/10

Hollow states for sale
Public assets auctioned off
Get in line for deals

Greece is Europe's First Hollow State

Some of you may know that I'm a fan of John Robb's work over at Global Guerrillas. His thesis that transnational actors are working to hollow out nation states is proving to be more accurate with each passing day. Check out this news item on how Goldman Sachs has appropriated Greece's wealth:

The bankers, led by Goldman’s president, Gary D. Cohn, held out a financing instrument that would have pushed debt from Greece’s health care system far into the future, much as when strapped homeowners take out second mortgages to pay off their credit cards.


Athens did not pursue the latest Goldman proposal, but with Greece groaning under the weight of its debts and with its richer neighbors vowing to come to its aid, the deals over the last decade are raising questions about Wall Street’s role in the world’s latest financial drama.

Goldman bankers possess asymmetric information, i.e., they are probably more well informed of the workings of financial markets than Greek civil servants who are overpaid just to make it through the day. When this trend reaches full bloom here in the U.S., we can expect to see bridges and toll roads owned and operated by investment firms. Ownership of municipal assets will be auctioned off by your bankrupt city and state governments to feed their employee unions' pension funds.

If you can't beat 'em, join 'em. I'd like to get in line to buy some publicly owned assets. The Golden Gate Bridge would look great with the Alfidi Capital logo on it.

Nota bene; Anthony J. Alfidi has no investment position in Goldman Sachs or Greek debt at this time.

A Bonanza for Aardvark

Google recently bought a startup called Aardvark. I wouldn't normally comment on a Web 2.0 buyout but I'll mention this one for a special reason. See, last night I crashed Aardvark's celebratory party at a SoMa nightclub called Temple and saw their employees partying like it was 1999. Remember 1999? It was the height of the dot-com boom and everybody in SoMa was launching Internet startups that were supposed to make us all rich forever.

I missed out on all of the early web hoopla in the '90s as I was otherwise employed. This Aardvark deal is a rare throwback to that era. Congratulations, folks. The outgoing CEO (and now nouveau riche Web 2.0 rock star) gave a rousing speech thanking his employees. I enjoyed the open bar but I tripped over the giant Buddha statue in the entryway on my way over to claim a free Heineken (and I hadn't even had my first drink yet). I met one of their software engineers who'd never been through a transaction like this. I only had one piece of free advice: The best job security comes from one's own abilities and not some big corporate parent. I'll bet some future serial entrepreneurs were born that night.

BTW, if you're wondering how I found out about this party, let's just say I'm well-informed enough about The City's social scene that I can always find a way into places where I'm not supposed to be. ;-)

Nota bene: I have no investment in Aardvark or Google at this time, although Google is the web ad distributor for Alfidi Capital. I have no investment in Heineken but I do contribute to its bottom line with the occasional purchase (just not last night, thanks to Google's generosity with the open bar).

The Limerick of Finance for 02/13/10

Greek debt gives the Euro some pain
Germany's skepticism remains
When they're all out of cash
Euro markets will crash
America has little to gain

The Haiku of Finance for 02/11/10

China selling debt
No more appetite for risk
Yield curve starts to rise

China Shows Its Hand, Smacks U.S. Debt

China's alleged move to sell the riskiest assets in its foreign reserve holdings is the talk of the markets. The Asia Times isn't exactly the most reputable news outlet, but no official Chinese source has yet moved to dismiss or deny the alleged leak so it may turn out to be legit. This (alleged) turn of events should be the final nail in the coffin for investors' expectations of recovery, if the Greek bailout saga hadn't accomplished that already.

Get ready for the next massive leg down for U.S. equity prices, coming soon to a 401(k) balance near you.

The Haiku of Finance for 02/10/10

Bargain real estate
Be careful what you look for
Some of it won't sell

Hits and Misses in "Bargain" Real Estate

I've tried searching Yahoo! Real Estate for listings of foreclosed property available at dramatic discounts. The problem I've encountered is that many of the listings at the lowest end of the price range are simply too good to be true.

There are dozens of listings at any given time for properties priced at $5000 or less in the San Francisco Bay Area. I was intrigued until I showed the listings to a real estate professional. She cross-checked them with what's available on her master listing service and discovered that many of these bargain listings are in fact errors. Many of the lowest-priced properties are usually people's garages, mother-in-law rooms, or other odd pieces that absolutely cannot be sold separately from a primary listing. When something looks too good to be true, it probably is too good to be true.

I think Yahoo! Real Estate is a good tool for finding reasonably priced foreclosures, like stuff that's 20% off. I'll write more about foreclosures when I find some properties worth considering.

Peak Market (Finally)

Perhaps Mr. Market has finally come to his senses and realized the recovery isn't happening. I tried to tell him last year that he was overvalued at Dow 10,000 but you know he never listens to me. Maybe now he's finally listening . . .

. . . to the creaking sound of European economies straining under huge sovereign debt loads . . .

. . . to the winter storms raging outside his window that are driving up the cost of energy . . .

. . . to the sobs of unemployed workers as small businesses continue to fire them.

At any rate, no matter who or what has his ear, Mr. Market is nudging back in the direction of the bears. I couldn't be happier, because I've got some cash to spend on bargain-priced stocks.

AMB Property Still Losing Money

In the ongoing debacle that is commercial real estate, AMB Property reveals the end of a bad year:

The year’s losses, primarily the result of impairment charges in the first quarter, more than quadrupled the $6.8 million loss in the previous year. In the fourth quarter, the situation eased as demand started to turn around. Fourth quarter losses came to $10.1 million, compared with a $199.2 million loss in the fourth quarter of 2008.

I do pay attention to companies in my backyard, like San Francisco-based AMB. Investors looking for contrarian plays might be inclined to consider a stock like AMB as a turnaround possibility. I'm more skeptical, given the company's negative net income two years running. Their long term debt has also been increasing for three years, which IMHO is not a good sign in a recession.

I seriously think the real estate sector has further to fall.

Nota bene: Anthony J. Alfidi has no position in AMB at this time. He is long puts on IYR as a bet against the entire real estate sector.

Container Traffic Up; Shipping Stocks to Follow?

Check out how rapidly the price of shipping stuff is being bid up:

The spot rate for shipping from Hong Kong to Los Angeles leaped by 20.5 percent to more than $2,000 per 40-foot container over the past week, according to Drewry Shipping Consultants.

It looks like shippers' collective decision last year to sideline some of their container ships has contributed to the lack of cargo space available, thus the speedy rise in bids for remaining spaces. This is extremely good news for shipping stocks in the near term. One question: Do they plan to keep some of their container ships idle indefinitely? If the recovery proves to be a head-fake (as I suspect it will), the cost of bringing some ships out of mothball status will be a waste.