Friday, January 30, 2009

For Profit Education Won't Remain a Safe Haven

I've always considered myself a value investor. However, this past year I've morphed into a reverse value investor: a short seller. Since the trend of the market has been downward, it has been easier to find value in overpriced securities as opposed to finding the undervalued gem that will still go down in a down market.

The next bubble to burst is the for profit education stocks. These companies have actually gone up in the last year! They sell at high multiples and momentum players are apt to push them up further. The value of the education they provide is dubious and their students can't afford their astoundingly high tuition without credit cards, home equity, and lots of student loan debt. At some point this is going to end. But right now investors believe that the avalanche of layoffs will lead to enrollment increases as workers become willing to pay for retraining and the Obama stimulus will help fund that retraining. Maybe. I think it's all baked into the stock prices of ESI, APOL, DV, COCO, CECO, and STRA. In fact it is singed and over baked. But I'm afraid of getting run over by the momentum trade. So I need to wait here, but there will be money made betting against this industry.

While I wait for the opportune time to bet against the above names, in addition to my regular short bets, I've begun to move more money into anti-inflation investments. For months I've held RTPIX , the inverse 10 year treasury, VFISX, a Vanguard short term treasury fund, and GLD, a gold bullion ETF. I've recently added to all three. The 10 year yield has been steadily rising and gold has been charging. There are reports that foreign governments are not buying as many treasuries as they did during the flight to safety. The safety flight pushed yields down and it appears that they are going up as investors reconsider how long they can stay with negligible yield and a deteriorating currency and credit rating. Inverse bonds or TIPS should be a reasonable place to park some money.

I've been studying the remaining merger horizon to see if there is a safe replacement for PSD. I haven't determined a likely candidate yet, but hopefully the market will present one. Arbitrage has been one of the few bright spots of the past 6 months.

I really want to short a trade school, but I can't.

Thursday, January 29, 2009

Vulcan materials Issues Junk Bonds. The Dividend Is Not Safe.

Is Vulcan run by managers that understand business or kids playing in a big sandbox? For shareholders sake I hope management isn't just a feel good bunch, but logical thinkers that will do what is right for the company. You can't fix a company by avoiding tough decisions. 

Today VMC filed a SEC document detailing $400M of new long term debt. The bonds yield 10.375% and 10.125%. That's about 8% more than Treasuries. The rates are punitive. The proceeds will be used to repay short term debt and maturing long term debt. Since they're paying 10+%, rather than using internally generated funds, for the funds necessary to repay debt,  I assume that cashflow hasn't been robust. 

If cashflow hasn't been robust, borrowing costs have risen, and projected net income is approximately 100% of VMC's dividend, why pay a dividend? Or why pay as large a dividend as they have been paying. With 110M shares outstanding and a $2 payout, cessation of the dividend would free up $220M to boost liquidity.

That's what a good businessman would do. Conserve the cash until better times. Don't gamble with having to go back to the banks again and pay a higher interest rate. Yes, shareholders will be disappointed, but the price will drop further if the company gets into really hot water down the road.

Every day it becomes clearer that the Obama stimulus is not going to be a road and bridge building bonanza. The numbers are puny compared to original hopes. That means that road building will not rescue residential and commercial shortfalls. Improvements in diesel and liquid asphalt pricing won't either. The quarterly numbers to be announced in early February will fall short of easily earning their dividend. Their guidance is likely to be hedged and paint 2009 as another difficult year.

At the high multiple that VMC is presently valued at there isn't any room for dividend cuts, lowered guidance, or the media tallying up the pittance in the stimulus devoted to roads and bridges. My short position can only improve.

Friday, January 23, 2009

Merger Arbitrage As A Substitute For Cash Equivalents

The past fifteen months have been instructive to all investors. Painful as well. No one, including myself, has had the right vision that resulted in consistent profits. Even short sellers closed out profitable trades and bottomed fished stocks that negated their short vision. 

The world is awash in cash and it yields virtually nothing. Nobody's ready to jump back head first into equities, government bond yields are extremely low and a bubble is percolating, the recession makes corporate bonds appropriate only for amateur credit analysts, municipals are going to see tax collecting problems and defaults, and bank CDs are very low yielders. An exception to the last statement is available for those that are willing to put money into the country's worst banks in amounts that are under the FDIC umbrella.

So what do you do with all of the cash you've pulled out of equities? Cash , while keeping you solvent, doesn't grow net worth, send the kids to college, pay for retirement, or let you sleep well at night when you're worrying about the foregoing. Wrigley, Budweiser, Puget Sound Energy and other merger arbitrage opportunities have offered very attractive returns, far superior to money market investments.

In normal times merger arbitrage is a game of pennies. This past year, with the credit markets in turmoil, the spreads available to willing investors have been generous. Certainly, and especially in this market, all announced mergers are not completed and an investment in the acquiree can end up in a loss. but deals are still getting done and the spreads, at times, have been exceptional.

Wrigley and Bud allowed the arbitrageur to buy shares, at a large discount to the closing price, after almost all of the risk was removed from the transaction. Puget Sound was, and is still, a very similar situation. Several weeks ago the stock was selling for $23 and the takeout price price was $30. There was some risk of the deal falling apart, but if it did, you would still be left with a good utility that pays a dividend. It wouldn't be the worst investment in this market. Since then, the final regulators have blessed the deal, closing has been set for February 6, the company has said they will pay an additional pro-rata dividend till closing, in addition to previous shareholder approvals and regulatory approvals. Still, you can buy PSD for about $29 and get back $30 on or near February 6th. Put $29 in a savings account, money market fund, or any other short term investment and see if you get back $1 in a years time. Yes, it's possible the deal won't close, the Attorney General of Washington has until January 29 to appeal the approval that his office has already given, but the odds are looking very good that money can be put to work effectively in this arbitrage.

Southwest Airlines: The Best For Less

I've never owned an airline stock; always thought it was a poor industry. Warren Buffett waded into U.S. Air a decade or so ago and reminded himself that, even if cheap, a poor company in a lousy industry isn't necessarily a good investment.

But I've always tried to fly Southwest when possible, both because of fare pricing and service, and found LUV to be an excellent experience. I've flown all the others and rarely find myself pleased. Even if ticket pricing is good, service isn't. The experience is clumsy and often irritating. So I've always watched Southwest's equity since it was the best operator in a tough industry. 

Several days ago the company reported their latest results and beat analysts expectations handily, pre-one time items. They walked investors through the capping of their fuel hedge program, reported on curtailing underperforming routes, and using the freed up aircraft on newly opening slots in Minneapolis and LaGuardia. All of their load factors and yields were good. And they hadn't forgotten about their customer experience as they remained adamant about not charging for baggage and other customer irritants.

The market heard Southwest's message and the share price went up several dollars. I was on the cusp of breaking my internal rule of investing in a bad industry and I was rescued by a rally in the stock. My potential book value purchase of the country's leading airline was derailed.

Today the market doesn't like Southwest and has pounded it down to the pre announcement  price range. You can buy the nations pre-imminent airline for .8XBook and at about 4.5 X Cashflow. You get sound management, an up-to-date fleet, happy customers, a reasonable cost structure, and a lid on the impact of rapid decreases and increases in fuel. 

As this piece is being written LUV is $7.90 and I've pushed the "buy" button. The industry will suffer during this  economic slowdown, but LUV has the balance sheet, operating margins, and management to do well at the expense of their competition.
I'm hopeful  that I don't learn the same lesson that Buffett must have as he no longer has any positions in the airline industry. 

Saturday, January 17, 2009

M&A May Become 2009's Only Positive

The economic horizon appears bleak. Yet many money managers reassure us the the market is a discounting  mechanism and will turn upward six months before the economy improves. At some point these optimists will be proven correct. But I fear that the second half of 2009 will not produce the market wide results they forecast.

The bright spot of 2009 will be in mergers and acquisitions. Only the strongest of corporations will be able to participate on the buy side as this year's buyouts will not be heavily debt influenced. The buyers will need strong balance sheets, lots of cash, and impeccable reputations that induce cautious bankers to lend. 

As the world's economies are in the midst of slowing business activity, corporate growth has to come from somewhere and many companies will choose to buy it as opposed to concentrating on organic growth. Strategic and bolt-on acquisitions will accelerate as the year develops. The strong will become stronger.  We will see similar combinations to Mars/Wrigley and InBev/Bud; substantial corporations becoming larger.

While owning the acquirers with their long term growth prospects and dividends is not a bad strategy, owning the Buds and Wrigleys of 2009 will go a long way to improve a portfolio's performance in a difficult year.

Pundits often opine that 2009 will be the year of the stock picker. But buy and hold stock pickers better be buying for 2010 and beyond and not troubled by further declines during the current twelve months. I'm more comfortable with lots of cash, a core portfolio of leading, dividend payers, a steady stream of covered call income, and finally, some selected buyout guesses and their advisor.

The buyout guesses are just that, guesses. Most will be wrong, so they still need to be worthy companies. Opportunities to extend a brand or add volume while minimizing duplication will look attractive as ways to keep excellent companies growing in a recession. Activist shareholders will do their part in prodding organizations to combine. Likely industries ripe for consolidation are energy, medical technology/instruments, and consumer staples. Lots of companies to choose from.

A narrower choice is among the helpers. Which bank will gain share at the expense of the American investment bank melt down? For reasons that I've mentioned before, Lazard's lack of proprietary trading and lending and their worldwide reach, LAZ will benefit from the most active part of the market in 2009-10. Buying the helper is easier than finding a seller, so that's what I'm doing.

Tuesday, January 13, 2009

Berkshire Hathaway Post Warren Buffett

The legendary investor, Warren Buffett, when asked what will happen when he is no longer at the helm of Berkshire, always is quick to assure us that he has identified qualified successors to run the company and manage the investment portfolio. Besides, he feels fine and his doctors proclaim him in good health. I believe Warren. He has a plan and who am I to possibly criticize the individuals that he selects as his heirs apparent? Additionally, his diet is similar to mine, lots of cheeseburgers and steaks and, best that I can tell, his exercise routine is as infrequent as mine. So, I’m not worried about Warren’s imminent demise or his designation of successor management.

Conventional wisdom has it that the Berkshire price is discounted for the eventual death of its legendary investor and leader. It also is likely discounted for the conglomerate nature of Berkshire with its many disparate parts. Despite the discounts, Berkshire has been a wonderful success story financially for its shareholders and an important instructive lesson in prudent investment techniques and business ethics. While I no longer hold a Berkshire position, I have certainly benefited from Warren’s performance, discount or no discount.

If Berkshire is such a wonderful company and it sells at a discount already that reflects the ultimate demise of Warren, then why should we be concerned about that eventual happening? The answer is found in the composition of the company’s portfolio of businesses. Fabulously successful entrepreneurs exchanged control of their companies to Berkshire for lots of cash and the ability to continue to run their baby unhindered, plus access to, and the friendship of Warren Buffett. For years the tradeoff has worked wonderfully for all concerned.

I would suspect that Buffett would suggest to his successors that they manage Berkshire as he has, both in the investment area and in the shepherding of the conglomerate companies and their managers. But will they? Strong managers tend to put their own stamp on the companies they run. They also won’t be given the benefit of the doubt, as Warren was, because of his esteemed reputation, in similar situations to Salomon Brothers and General Re. The new guy[s] will know that they won’t get any free pass and will want to keep a closer watch on subsidiaries than Warren does. That will mean more reporting and trips to Omaha for consultations. Home office staff increases and reporting responsibilities will evolve and, of course, there won’t be any phone calls or interaction with Warren. Instead there will be reporting and performance reviews.

Expectations, reporting, and performance reviews are appropriate, but if you are already a billionaire and your family is financially set are you willing to be second guessed by a mere multimillionaire CEO? Maybe the world’s richest man is worthy of asking you about your subsidiary’s latest quarterly results, but how will it sit when a new CEO inquires and has suggestions and expectations. Tension is inevitable.

The bulk of Berkshire is insurance and its invested float. That shouldn’t be impacted by my concerns about the conglomerate operating companies. But, those companies are significant and I believe there will be rapid turnover at the executive level and sub par performance under a new regime. Overall performance will be retarded as the new Berkshire management divests itself of many subsidiaries. In the meantime, Wall Street gets confused or disillusioned and the share price comes under pressure.

Without Warren, Berkshire will be under share price pressure until it slims down to an insurance holding company with significant utility and industrial concentrations. I sold my position earlier this year and while that decision looks good today, I probably sold too soon, as Warren undoubtedly remains healthy, wise, and in control for years to come. But when that time does come, his billionaire subsidiary presidents won’t like the new regime.

Sunday, January 11, 2009

Uncle Sam Needs To Follow His Own Medicine

Once upon a time when banks were run by bankers that had their net worths at risk, the cardinal rule was: "don't borrow short and lend long." The Savings and Loan industry never learned that maxim and it has since disappeared. Regulators, in response to the S&L crisis, put renewed emphasis on Asset/Liability Management and hoped to prevent timing mismatches in bank funding and investments. To some degree that has worked and bankers have found other ways to roll the dice and risk stockholder money.

But the regulators, Fed, OCC, and FDIC, know better. Since they are the government, you would think the Treasury would consult their experts. If bank examiners are knowledgeable enough to advise and punish banks, then you would assume that they should be consulted regarding the U.S. Government's funding. But, alas, Treasury doesn't seem to be asking for advise.

The recent bailout programs and upcoming stimulus will result in huge borrowings on top of our built-in deficit. Short rates are near zero and 10 year Treasuries in the 2s. The politician's best choice for tallying government deficit spending is to fund everything with short money, even if the proceeds have been invested in bank preferred stocks, mortgage backed securities, and other, various illiquid assets. The stimulus spending will also be on longer term projects like road building. The funding should be longer term. Ten year bonds would be appropriate and a return to 30 year funding would make even more sense given the low interest environment we currently enjoy.

If the government is going to take riskless return away from savers and force them to take more risk to find yield, then they should at least minimize the expense to the taxpayer as taxes are sure to increase at some point with the government's short term funding strategy. Selling long term treasuries to fund the deficit is the prudent thing to do. The government's bank regulators would require it because it makes prudent business sense. Our governmental leaders should take their own advise and sell long term treasuries while the buyers are still present at todays low rates. 

Friday, January 9, 2009

Vulcan Materials' Dividend And Share Price Are Not As Solid As Rock

Vulcan, the country's largest aggregate company, is like an easy first date. It's easy to get interested as it is going to make you feel good, but it is also real ugly. The whole experience is a one bagger.

This company, and industry, is fundamentally sound. It makes money year in and year out. It can do extremely well when construction is on a roll. It has even done well the past several years when construction has been constrained. But it didn't do well by selling more rock,gravel,cement, concrete, and asphalt. While volumes were decreasing, the industry had the pricing power to increase prices. Rare, but factual. Can that phenomenon continue in 2009?

The upcoming Obama stimulus has created many believers and the stock has moved up from a November low of $40 to the $70s. It has recently traded down to the low $60s, but has still enjoyed a large stimulus move. Last year the stock advanced on the thesis that it was very difficult to obtain permitting for new mines and any company that already had  facilities permitted and near  metropolitan areas possessed unlimited pricing power [I buy that rationale in good times]. This year it has moved on the hope for an Obama stimulus that is heavy on road and bridge construction. 

The stimulus will help, but it won't turn this ugly date into a beauty. Aggregate companies are three legged stools. They depend on housing, commercial, and road building. The first two legs of the stool are broken. The third, government sponsored road building, is about to get a boost from the US taxpayer. It comes at the right time as state and local tax revenues are falling and state and local road building funds are under pressure. My guess is that the stimulus is going to replace lost tax revenues and will not result in an explosion of road construction activity. The VMC bull bet is that the stimulus spending will juice  governmental spending enough to offset the continued weakness in housing and commercial construction. I believe that the koolaid  drinkers will be disappointed.

Analysts currently expect Vulcan to earn $1.96 in 2009, approximately the same as '08. If pricing power holds up, they may. That level of performance results in a EV/EBITDA of 12. In today's market that is a high cashflow multiple for a company that makes less money each year, sells less product each year, and is paying out 100% of earnings in dividends. That's right, a 100% payout ratio when they pay a dividend of $1.96. That largesse doesn't make sense in our present economic climate. I also won't make sense to the company's bankers. You conserve cash in bad times, you don't keep paying it out unless you are Bernie Madoff and still have an unlimited source of funds.
Vulcan is going to reduce their dividend. How much I can't predict, but they will need to reduce their payout.

It's likely that analyst earnings estimates will be cut, quarterly earnings comparisons will be poor, revenue will decline, and, finally, a dividend cut will lead to a decrease in share price. I am short this company and even though it may be swept up in another bout of Obama stimulus in the coming weeks, I believe it will be heading downward as reality sets in and the pixie dust wears off.  VMC is going to be a pretty date only if you are short or wearing a bag.

Wednesday, January 7, 2009

I'm no Kenny Rogers

You need to know when to "hold 'em" and when to "fold 'em". Having grown up into adulthood as a "buy and hold" investor, I've struggled with folding even when I senses that I should as I have always seen the market rebound and my net worth with it. I've done better this cycle as I have  sold shares, kept money on the sidelines, and sold some shares short. But, alas, I still have a large long portfolio. I don't know when to fold'em.

If it was easy I'd be very rich, but I'm not because it isn't.  
S&P earnings for 2009 are now forecasted at $40 and the S&P is currently at 925-that's 23 X earnings. P/E's at that level are not cheap, no matter ho much they have fallen. Yet that market seems to want to go higher and it probably will. For awhile.

I did through in the cards on NCC/PNC. I took my losses in my taxable accounts prior to yearend for tax purposes and jettisoned the IRA position this morning. I'll replace it with SPY as I'm not a good gambler and don't want to miss a bear market rally. Several other falling knives that have lacerated me have behaved nicely prior to today. TSO and TRN have made nice comebacks and, while still losses, worthy of waiting awhile longer.

Since the Fed has declared war on old people by driving short rates to zero, I've moved money from treasuries to FDIC insured money market accounts. There are crappy banks, still open, paying 3.25-4% APR and will give you 3.75% for 12 months. I'll take these yields until inflation arrives late in '09 or early '10. There are much better yields available in corporates and municipals, but you have principal risk and i've got enough of that in equities. So that's where some cash is ending up.

One bright spot is Bunge. It's up a bunch since I bought it several weeks ago and acts strong each day. Earnings are still projected for $8 in 2009 and it now sells for $56, or 7X P/E. It's a good company, but who knows how soybean shortages and Brazilian fertlizer pricing will play out. I hope they do. If they can produce $8 there is more to run and market action seems to indicate that others feel this way also.

I will continue to sell covered calls when my current ones expire later this month as the market isn't going to blast off even if it rallies some more from this level.

Time to play gin with the wife and show her how smart I am at cards.

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