The Haiku of Finance for 05/28/15

Rambling Lehman guy
Forget about bankruptcy
No one remembers

The Haiku of Finance for 09/29/14

Buying bankrupt tech
On sale in court for bargain
Rock bottom startup

The Haiku of Finance for 08/05/14

Unwind bankrupt firm
Lots of assets to sell off
Salvage some value

The Haiku of Finance for 08/04/14

Suckers for high yield
Holding bonds risking default
Guess who should go bust

The Haiku of Finance for 05/08/14

Fail to save enough
Outlive a portfolio
Bankrupt idiot

The Haiku of Finance for 03/15/14

Fast food bankruptcies
No one can afford mall food
Too poor to dine out

The Haiku of Finance for 01/20/14

Cycling bankruptcy
No more bikes for some cities
Can't buy from up north

The Haiku of Finance for 12/04/13

Finally bankrupt
Broke city can wipe slate clean
Rebirth of Detroit

Eminent Domain as Nightmare Fulfillment of Unfunded Public Pensions

Detroit's bankruptcy filing is making many other municipalities nervous about their unfunded liabilities for retiree pensions and benefits.  A drawn-out bankruptcy fight will be a nightmare for politicians who stake their reputations on good governance and successful turnarounds.  Government retirees are still a potent political force and will fight in court for what they think they deserve, regardless of the fiscal harm they cause.  States will sell assets to settle their debts if public employee unions do not willingly take cuts in promised benefits.

I do not know whether the Michigan State judge's injunction against Detroit for filing bankruptcy will be overturned by a federal court.  Bankruptcy law is rarely exercised for municipalities so any new case law will set clear precedents for whatever bankruptcy wave is coming.  There is plenty of precedent for one extreme measure that municipalities may consider if their backs are against a fiscal wall.  That would be the seizure of private assets under eminent domain whose resale will make municipal bondholders and pension recipients whole.

This nightmare scenario could easily unfold if state and local politicians believe fighting public employee unions in court will harm their re-election prospects.  The US Constitution prohibits the government from taking private property without just compensation but legal history leaves the definition of "just compensation" to state and local governments.  Consider also that property owners who endure a taking under eminent domain may be compensated in the form of a "condemnation award."  I'm not an attorney, but I'm under no impression at present that such an award absolutely must be in the form of cash or in-kind property.  My nightmare is that private property owners in Detroit or elsewhere may see their land seized and businesses condemned with their only "just compensation" as some new non-marketable junior security issued by a broke municipality just for such an occasion.  The IOU would of course be worthless but the property seized would be sold to other parties (presumably with political connections) and the proceeds used to fund pension liabilities.

Consider also that the people charged with enforcing this confiscatory doctrine - police, judges, government clerks - are all beneficiaries of this process if they depend on defined benefit pensions.  Their interests would theoretically align with fulfillment of a strict interpretation of contractual obligations outside of federal bankruptcy proceedings and against the interests of taxpayers and private property owners.  Finally, consider that legal precedent also allows the taking of personal property and intangible property.  I do not see any legal barrier to the confiscation of privately held liquid investments such as brokerage accounts or bank accounts.

This is a thought piece that I very much want to be invalidated.  I truly want Detroit to have a successful restructuring through federal bankruptcy proceedings that are unencumbered by state-level judicial maneuvers.  I do not at all look forward to the depressing prospect of desperate politicians, backed up by destitute law enforcement officers and government functionaries, confiscating private assets under eminent domain just to placate some very vocal unions.  I want to be wrong about this prospect.  I would like bankruptcy attorneys and legal scholars to debate this scenario in the public sphere and prove my concerns to be unfounded.  

The Haiku of Finance for 07/18/13

Detroit has gone broke
Cut unions and their pensions
Can't afford them now

Bankrupt Detroit Officially Ready to Downsize

Detroit has finally filed for bankruptcy.  Many years of population flight, an eroding tax base, excess civic infrastructure, and overpaid public employees have sealed the city's fate.  I discussed Detroit's condition one month ago.  The city simply did not have enough time to fix all of its problems before its bills came due, and no external rescue could have stabilized the city's finances.

Detroit is now free to nullify any city employee union contracts that burden it.  No city deserves to be a permanent hostage to union greed.  It is also free to implement its long-discussed downsizing plan.  I sure hope they take my initial analysis seriously and go for as much permaculture as space will allow.  The sad recent spectacle of Detroit fast-food workers agitating for higher wages was comedic.  Those folks won't be laughing once their fast-food joints are bulldozed for farmland but they will certainly be eating healthier.

I have no sympathy for any investor who bought Detroit municipal bonds.  The handwriting for bankruptcy was on the wall for a very long time.  Bondholders will get nothing.  

The Slow-Motion Financial Implosion of Detroit

I wrote about Detroit's financial problems three years ago when the city's leadership had a viable plan to fix the city by downsizing its infrastructure.  The Detroit Works Project had a blueprint for renewal in 2010.  The city has since squandered the time and money it could have committed to that plan and is now facing imminent bankruptcy.  This disaster was a long time in the making.

Read Detroit's financial statements.  The CAFR for FY 2012 has the bottom line up front on page 2, with an accumulated deficit of $326.6M from several years of operating deficits.  The CAFR itself is ironically interspersed with happy photos of fun things going on in Detroit.  Maybe next year's CAFR can show the Mayor and his state-appointed emergency financial managers turning shovels on bare dirt where their offices used to sit.  The Single Audit Report is even worse, with up-front warnings of material weaknesses in Detroit's internal controls over financial reporting.  The federal government has every right to cease funding programs in Detroit given these weaknesses, but politics means more than financial sense.

Detroit's credit rating at Moody's has seen almost nothing but downgrades and downgrade reviews since 2010, with the exception of February to December of that year when credit facilities backed by the State of Michigan stabilized Detroit's outlook.  The city had that window of opportunity (during which I wrote my blog article on Detroit's potential for unbuilding) to quickly begin its downsizing.  The city instead has been paralyzed by public employee unions whose members have enjoyed generous pay and benefits for years and are still resisting fiscally responsible cuts to benefits.

I think Detroit had the right intention to downsize itself but picked the wrong means to execute.  Reviewing the Detroit Works Project's strategic framework reveals color-coded maps of the city's center.  The city designated much of its inner core as blighted where no redevelopment would be allowed and tried to pigeonhole specific industries into specific neighborhoods.  That's micromanagement, and it's dumb.  Detroit is in no position to pick and choose which companies it will allow to move in.  Contrast this approach with San Francisco, which has given tax breaks to several digital media companies that came to The City regardless of the neighborhood where they chose to settle.

Detroit's detailed plan for renewal is probably going to come undone out of necessity if receivership forces it to move faster.  Farms and ranches will sprout again within city limits and former unionized workers had better learn how to plant rows of corn.  City managers should radically and immediately liberalize their approach to zoning.

The lessons of Detroit for the state of California are obvious.  Sacramento policymakers are committed to more of what hasn't worked:  more spending on underperforming public schools, more taxes on high income earners, more regulations on business, and more protection for public employee benefits.  None of that is going to work in Detroit now that Motor City is crossing an event horizon on its way to collapsing into a singularity.

Fisker Automotive, the DeLorean of the Green Car Era

Fisker Automotive is probably out of gas, even though its cars aren't supposed to use much gas.  It laid off almost all of its workforce except for a skeleton crew of office staff who will try to sell the company or wind it down in bankruptcy.  What went wrong with this company?

The Fisker Karma is a nice-looking sports car, but just try fitting inside.  The EPA rates it as a subcompact because the interior is so small.  I've never heard of a car marketed as a luxury sedan that was actually determined to be a subcompact according to its structure.  Oh, let's not forget that the first ones out the door were recalled due to a risk of battery fire.  The battery maker, A123 Systems, went bankrupt in 2012 and was bought by a Chinese company.  The car broke down on Consumer Reports' track before it even got started with a road test, earning it a failing grade.  The thousands of suckers who pre-ordered a Karma will probably never get one; I wonder if they had to pay cash up front.

This reminds me a little of the infamous DeLorean Motor Company from the 1980s.  Its singular product, the DMC-12, was as overpriced and unimpressive as the Fisker Karma.  The DeLorean legacy only exists today as a spare parts repository and kit car builder for a handful of enthusiasts.  Fisker fans can hope for a better outcome, but hope is not a method.  The federal government may end up owning Fisker's assets if it can't repay a DOE loan.  Good luck getting those parts and tools out of a government warehouse.  I have an image in my head of the last scene from Raiders of the Lost Ark, where the U.S. government sticks the Ark of the Covenant into a warehouse where it is presumably lost forever.  That Ark was really a superpowered energy source that destroyed whoever tried to use it.  Well, the Fisker line of cars was supposed to be pretty powerful but the business ended up destroying a lot of capital.  Thus ends my convoluted analysis for today.  I hope you were entertained, but hope is not a method.

Full disclosure:  I do not own any Fisker products, nor did I ever consider buying such a car.  I drive a gas-guzzling Ford Mustang that hums better than any wimpy electric car.  

US And UK Have Their Own Cyprus Bank Plan

Cyprus delivered bad news to a lot of good folks who thought their money was safe in banks.  Don't think it can't happen here, in the U.S. of A.  It can, and it probably will.  The U.S. and U.K. have jointly developed a resolution plan for insolvent banks.  The good news is that the plan is designed to avoid tapping out taxpayers the way Hank Paulson's emergency $800B TARP did back in 2008.  The bad news is that this plan will hit depositors where it hurts.

Bank depositors are in fact unsecured creditors of a corporation.  Think about it; you're loaning money at interest to a business that promises to pay you on demand.  If that business goes bust, you lose what you loaned.  Federal deposit insurance masks the risk that a depositor will not get back all of their money.  I have no problem with depositors taking a hit on sums over and above anything covered by insurance as long as such risk is explained to them in writing when they open a bank account.  Plenty of people don't read the fine print.  I do read account fine print, and I also read financial statements to ensure I stay away from troubled banks.  

The joint U.S./U.K. plan is designed to wind down parts of troubled banks while preserving other parts that provide vital services to the economy.  The goal is to keep thinks like merchant services and check clearing functional while derivatives books are unwound.  The impetus for the 2008 mega-bailout was that viable non-bank companies faced the very real chance of getting locked out of short-term credit markets and not being able to pay their vendors.  That would have destroyed healthy parts of the economy.  No one wants to go through that again. The plan to avoid a repeat of that scenario is now in the public domain and the troika is using parts of it in Cyprus.  The experiment so far is proving successful in keeping the economy of Cyprus functioning.

Suntech Power Holdings Watches Its China Unit Go Bankrupt

I haven't paid much attention to Suntech Power Holdings (STP) other than to note in 2008 that they claimed the ability to manage price declines in a strong market.  Well, they're back in the news today and those claims from four years ago look like a bunch of hooey.  Suntech's Chinese manufacturing subsidiary is in bankruptcy proceedings.  That's just great.  China's strategy of putting foreign solar competitors out of business by subsidizing its cheapest domestic manufacturers has now come full circle.

No one is willing to turn off production at Suntech's Chinese plant as long as state-owned enterprises have a hand in its restructuring.  Local Chinese officials willing to help restructure the company's debt no doubt wonder what's in it for them.  Corruption will enrich some Party officials in Wuxi Suntech Power Holdings' regulatory food chain while continued overproduction depresses PV panel prices.  The tragedy of China is its inability to see how the state-directed mechanisms of its miracle growth story are now harmful as industries reach maturity.  I noticed that Suntech has a San Francisco office at 71 Stevenson Street.  Maybe I'll swing by and grab some coffee before they put the office furniture out on the curb for pickup.  Nah, I'm too busy.

Asking what comes next for bondholders gets an easy answer:  Bondholders get nothing.  One would know from reading the company's recent financial statements that they were having difficulties.  Their Form 20-F filing from April 27, 2012 has financial data after page 117, showing assets exceeding liabilities but with a retained earnings deficit of -US$365M for 2011.  They did incur a billion dollar loss that year, so things were looking bad even then if anyone cared to look.  The accounting of some Chinese publicly-traded stocks is so thoroughly obscure (and sometimes fraudulent) that nothing reported from that country can be taken seriously.  No sane U.S. investor could possibly decipher a Chinese manufacturer's business model unless they speak Chinese, have Chinese relatives, have lived in the mainland for years, and have a personal network of contacts in the Party who can feed them unaltered economic data.

I still haven't found that long-term solar play for my own portfolio.  I'm glad I didn't pick STP as some kind of sector play back in 2008.  I still like solar power and my adage from back then still stands:  The least complicated technology that uses the most widely available source material has the greatest likelihood of long-term commercial viability.  Some U.S. energy company could make a lot of money for decades with a concentrated solar power installation in the American West.

Full disclosure:  No position in STP at this time.

Relative Value of Leading Pawn Shop Stocks

Tough economic times drive demand for unconventional financial services.  Pawn shops cater to desperate borrowers who have low credit scores, troubled financial histories, and other problems that make them unsuitable risks for mainstream banks.  Opportunists can open their own pawn shops or invest in existing ones, including some that trade publicly.

Cash America International (CSH) is trading at about the mid-point of its 52-week range.  Its long term debt is almost five times its net income (far above the 2x level I prefer) and fluctuates wildly from quarter to quarter.  It has positive FCF but that fluctuates too, and I wonder why their capex is non-negligible if their business model is based on franchising (i.e., the franchisee should be paying the upfront store costs).  Its 5yr EPS growth and 5yr ROE are respectable but they're not beating their sector average.  That's too bad, because Cash America offers other non-storefront service like tax filing and insurance that can appeal to low income "non-banked" clientele.

EZCORP (EZPW) is trading toward the low end of its 52-week range but has a P/E of just over 7; that's bad news for trend followers but good news for value investors.  Its net income has shown a distinct upward trend for three years and its balance sheet has a manageable level of long term debt.  FCF is strongly positive.  Their product lines are very simple, focused on various types of loans for goods with no other services.  EZCORP's recent purchase of online lender GoCash reflects this loan focus.  Their 5yr EPS growth and 5yr ROE are remarkably high, beating the sector average.  I must admit, I'm impressed.

First Cash Financial Services (FCFS) trades at a P/E of 20 and is near its 52-week high; my gut tells me it's probably overpriced on those metrics alone.  Their net income has risen dramatically in the last three years.  They did an excellent job reducing their long term debt to zero in 2011 only to allow it to balloon again this year.  That debt is still manageable (less than 2x annual net income at present) but erratic changes like that are worrisome.  FCF is positive and their 5yr EPS and ROE figures are strongly outperforming the sector.  One strategic disadvantage of First Cash is its brand confusion.  They have five different brands but their services are so similar that such a brand family complicates their marketing message.

The three companies above taken together have a combined market share that does not come close to sector dominance, so none of them have strong pricing power.  Gaining pricing power in a sector like this is nearly impossible because product inventory is so unpredictable in quality and turnover time.  Winning in a sector that emphasizes discount goods means reliance on brand strength (i.e., whichever has the best word of mouth in low-income demographics) and physical location (i.e., near HUB zones, Section 8 housing, and other areas with low costs of living).  The whole sector is highly fragmented and localized, so despite some opportunity for consolidation through acquisition these national chains have little incentive to do so.  Economies of scale in financial services come from consolidating back-office functions, and pawn brokerage is mostly a front office affair.

I suspect that peer-to-peer lending will soon pose a major competitive threat to pawn broking.  It won't undermine the high-end segment where large loans are collateralized with luxury goods but it will affect smaller loans.  P2P lending is cheaper for the borrower and more transparent for the lender.  It is more of a threat to smaller pawn shops that lend small amounts (under $5000) and do have other complementary business lines.

Pawn brokers aren't the only financial players who can profit from the pain of distressed borrowers.  Investors can make some bucks from this growing sector.

Full disclosure:  No position in any stocks mentioned at this time.

Financial Sarcasm Roundup for 01/14/13

There are many analysts and commentators in the financial sector.  If any of them are more sarcastic then me, I haven't seen them yet.  

Wealthy people are increasingly turning to pawn brokers for fast cash.  This is great news!  Some rich people pride themselves on conspicuous consumption, and now the reverse is equally conspicuous.  I don't feel sorry for the Hollywood stars and musicians who pawn their bling.  Their agents had every opportunity to hook them up with competent financial planners.  Non-celebrities who pawn high-value items probably have something to hide, like a bad credit history that a bank would shun.  The companion piece on spoiled rich kids tells me everything I already knew about human nature.  People say they want to work hard but rarely do.  They say they want their kids to have strong ethics but cave in to their every whim.  Our species seems to be hard-wired for hypocrisy.  Something in our genes gives us a Dr. Jekyll / Mr. Hyde predisposition to take impulsive action and then rationalize it afterwards.  Anyway, maybe wealthy people can pawn their spoiled kids' trinkets next once they run short of bling.  The brats don't deserve to inherit any of it anyway so the parents might as well haul it off.

Some Greeks may wish they had expensive stuff to pawn off.  Desperate Greeks are illegally chopping trees to get wood for heating.  Plenty of Americans will be following suit in a couple of years.  Sedentary suburban lives mean Americans' survival skills have atrophied and not everyone owns proper hand tools.  How about a government stimulus program to retrain people for careers in urban scavenging?  It sure would be good for sales at Home Depot, especially if the funds are programmed into EBT cards.  Yeah, I know, it's poor taste to ask people to prep for an obvious contingency.

Bankruptcy is one obvious contingency for the financially strapped.  Even bankrupt businesses are forced to pawn themselves.  Impatient banks are forcing busted businesses to find buyers ASAP or lose their last remaining lifelines.  The hidden context is the strong position of banks as senior creditors thanks to TBTF status.  Any subordinate creditor of a troubled company can expect to be pushed around in Chapter 11 thanks to Dodd-Frank.

Senior creditor privileges aren't the only advantages the SIFIs have under captured regulatory regimes.  JPMorgan may or may not release its report on how the London whale lost billions, depending of course on how the bank's senior officers feel on a given day.  The UK's concern for privacy protection comes pretty late after the disclosure of the names of the Whale, his team members, and the senior executives who did not supervise his trades.  Those top dogs are still on the job, minus a few token terminations, and they have learned nothing.  Rest assured that business will continue as usual.

Business here at Alfidi Capital will also continue as usual.  I've learned a lot from reading about the mistakes of the people above.

The Haiku of Finance for 11/19/12

Hostess long-shot chance
Judge invites mediation
Both parties will talk

The Haiku of Finance or 11/16/12

Hostess is bankrupt
No more Twinkies for a while
Brand liquidation

The Haiku of Finance for 08/30/12

Spain is just like Greece
Austerity won't work well
Time to boot them both