Saturday, December 22, 2007

Let the MBA's talk to themselves

Too many young MBAs spend more time on the squash court than at the foot of accomplished investors. How else can one expain the herd mentality and foolish investment decisions.

Let’s examine some conventional investing wisdom:
1. New capital, even expensive preferreds, is positive even as it dilutes current shareholders. Therefore push the price up.
2. Taking a large write down on securities that no one can understand is a signal that management, or new management, is on top of the situation and the stock has now bottomed. Therefore, don’t run for the hills or sell short, buy and push the price higher.
3. Agree with the economist fraternity and ignore rising food and energy costs and only concentrate on the “core rate.” People don’t eat or drive so non-core inflation won’t produce the same result as a tax increase. Therefore, keep cheering for lower short term interest rates and push all stocks up as rising prices aren’t as powerful as lower rates.
4.Emerging markets are growing so fast that a slowing American economy will not affect the Third World. Therefore pile into U.S. multinationals and Emerging Market companies and expand their valuations far past what their gowing earnings justify.
5. The list could go on for pages.

The ramblings above lead me to Citicorp. This money center bank hasn’t had good leadership for a number of years, its CEO was a former house counsel! It excelled at following trends and was willing to not only sell, but own securities that it didn’t understand. Its risk manaement was definately NOT crusty.

As I opined early on, the losses will keep coming ala Continental Illinois. The risk culture permeates the institution and it doesn’t only reside in the subprime mortgage portfolio, the CDO portolio, or the SIV that holds lots of asset backed commercial paper. The same management and risk managers that allowed that debt to reside on the balance sheet wasn’t able to discriminate and prevent poor credit from filtering into the LBO and Bridge loan portfolios, the home equity lines, unmonitored credit card portfolio, hedge fund lending, and aggressive merchant banking investments. Now that the auditors and regulators have started looking closer the other cockroaches will come out of the closet.

Selling high coupon preferred to Arabs may keep capital OK for awhile, but it is expensive and ,when converted, is dilutive. That capital won’t be enough to compensate for future losses attributed to the above problem areas that will develop. The dividend will need to be cut or eliminated as it represents billions of dollars of potential capital. Cutting the dividend may hurt shareholders, but so does dilution and both cause a reduction in share price.

I’ve had puts on Citi and think that bet remains a good one. It is likely that the dividend will be cut and the new president will announce losses greater than anticipated so that they are attributed to former management. The housecleaning won’t be enough though and losses will continue and capital will be strained for several years. Owning puts or being short is the place to be as the price will continue downward in 2008.

Saturday, December 15, 2007

2008 won't be anywhere near average

I haven’t written with any investment thoughts lately as I haven’t had any. As I wrote earlier, the market was likely to rally pre mid-December and then trail off as tax loss selling and economic realities set in. Amazingly, that has occurred.

My positions are mostly behaving in a good fashion. I used the rally to sell some positions at good prices and start more puts/shorts at much higher levels than earlier in the month. The flight to quality by institutions has caused my blue chip holdings to perform well. The only problem of late is in very short term bonds and I still have a good profit at these levels and I’m sleeping well at night. So all is well.

Now how do I make a good return next year if the “market’ isn’t going to give me an average year. First, I’m going to expect less and be happy withcoupon-like returns. Second, I’m going to continue to “time the market.” I usually don’t do that as I generally just ride through any correction as the trend has been upward for years. This time I think we have more negatives at work and the upward trend resumption may take longer. I’m willing to pull money off the table as it will get reinvested in fixed income investments at rates that will be rising. The safety feature of government bonds will only hold appeal for so long and then inflation and a weak dollar will demand higher returns. That evolution could happen quickly as inflation has been rampant and the media has only recently noticed and the Fed has only recently acknowledged that “headline” inflation affects consumers. I could get a large portion of my 2008 return from rising rates.

My negative bets are self explanatory. As they go down I make money. And as long as everyone flocks to multi-national blue chips that have an overseas presence, that portion of my portfolio will do well.

Wednesday, December 5, 2007

I may be the "greater fool" sellers are waiting for

This position started as a hedge to my MLM puts. The thought process was that if construction materials rallied and my puts lost value, then the RMIX position gains would minimize my pain. Luckily I did well on MLM and didn’t need the hedge. But, I fell in love with this little company and it has been a rocky relationship. The stock has dropped steadily and now resides at about $3.50, down considerably from where I entered the position. I’ve averaged down some, but those purchases are also underwater.

I think this company is too cheap. I don’t think it is a world class outfit and it doesn’t have a pristine balance sheet. Earnings have ben erratic and a significant portion of its business is tied to residential construction. It won’t dramatically improve margins and growth next quarter, or the one after. But it has been hammered worse than homebuilders!
So why do I like this little company and stay with a losing position? I ask myself the same question every day it retreats. It’s time to put the reasons to paper again and see if they still are valid.

First, I recognize that they are consolidators and as such have lots of goodwill on the balance sheet and around half of their capitalization is long term debt. So far I think they have done okay with their purchases. The last two have been bought for 1Xs and that isn’t astronomical. In the process they’ve bought market leading positions in the Bay Area of Ca, Sacramento, Detroit, West Texas, Dallas, and New Jersey.If add-on acquisitions are worth 1 X sales, then market leading positions have much more value.

They will make $.35 for 2007 and analysts say $.41 next year. So they make money, but not tons. They do throw off decent cashflow. Free cashflow after capital expenditures and debt service will be $20MM per the CFO. That means that as the debt has been serviced, the $140MM market cap earned $20MM and all the equipment was maintained. That 14% return looks good to me. They can control their cap-ex since they don’t need to replace as many trucks if they aren’t delivering as much concrete, so sell more and buy more mixers or sell less and you don’t wear out the fleet.

As I said, RMIX has bought two companies recently at one times sales. You can buy US Concrete today for about 1/2 sales. You won’t be able to, but the market has priced the stock that way. Take the value up to the $850MM sales volume and you need a stock price of near $10. An acquirer would get market leading positions in 6 markets, an up-to-date plant and equipment, and be able to get a market cap boost of their own stock since VMC, MLM, CX, CRH all are valued at much higher than 1 X sales. I like $10 much better than $3.50!
Finally, the CFO recently bought 15,000 shares with his own money and I’ve listened to him on presentations and he seems very competent.

Since the company is connected to homebuilding, it could continue to decline along with housing headline risk, but there isn’t a whole lot of downside left and if I have concluded correctly there is much more upside. I plan to continue to add to my position.
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