TB’s Quote of the Day: “Future shock…the shattering stress and disorientation that we induce in individuals by subjecting them to too much change in too short a time.” – Alvin Toffler. Who can say that this is not a daily occurrence? TB
…and all the wrong reasons. Keep in mind four things: the reasons were, the envelopes please: the bailout of AMBAC which is expected to be extended to MBIA and others although there is no certainty and no real details…isn’t the devil always in the details? New life to LBO’s as an SF-based private equity firm, Hellman and Friedman, did a relatively small deal…is there a lot of capital around for loans though? Lastly, the long-awaited IPO of Visa, big brother to Mastercard (MA)…perhaps stock symbol for Visa then should be PA?…Ma and Pa?…oh forget it! Then there is the hedge fund as the enemy. Lastly, today is last day for T+3 settlement for monthend which is also mid year for some big financial companies including Goldman and Lehman.
Today’s topics:
1. monotonous monolines
2. LBO’s, AKA entrepreneurs using OPM and OPD (debt) to buy companies and get rich
3. Veni, Vidi, Visa…or I came, I saw, I spent…now I’m broke…do IPO’s really help?
4. Hedge funds…helpful, disruptive, or both?
5. Monthend when viewed as expiration
1. Monolines. Can you think of anything more boring than a company who insures municipal debt? A Aa corporation has more chance of going into bankruptcy than a single A municipality…of course we know that is a distortion since during the Depression, 80% of the municipal defaults had been rated Aa or better.
When TB came into this whacky and wonderful…wonderful and whacky?…business in 1972, there was no insurance – municipal that is, he isn’t THAT old – some had tried it but failed as the terms were wrong…they insured the bond issue…the new wave merely guarantees the principal and interest, and since municipal bonds are weighted with more principal and interest on the long end even if the insurers have to pay the amount is small. Furthermore, when a municipality goes bankrupt there is generally a way of reorganizing as it is in everyone’s interest to keep a city, county, state alive. Examples of this are New York City in 1975 and Orange County in 1994. Of course if it isn’t a good enterprise and organized properly there is no protection and that is where municipal bond insurance should come in. The best example of this are hospital and industrial revenue bonds, but note insurance is only available on the ones with little risk of failure. The biggest failure was Washington Public Power Supply System which had two classes of bonds…some AAA rated due to a Bonneville Power Authority guarantee…and others that were A rated and had an implied guarantee according to two First Boston whizbang analysts who cost a friend of TB’s his career since he believed them and swapped his AAA’s for single A’s and then came the bankruptcy…shortly after thanks to a populist judge in Washington.
WPPS was the real reason that municipal bond insurance came into being, and the world is worse off for it as investors would see those AAA monolines insuring and buy without doing their own research. Still, all would have been fine had it not been for several new entrants who made it harder to make those profits although they had the invested reserves and an annuity of 25 basis points a year till maturity. Most enlightened investors like TB would have preferred no insurance and give us the yield. But it became like the UL or Good Housekeeping seals of approval. As with credit default insurance, it became issued for all the wrong reasons and relied on accordingly. Investors like major corporations, dare we say Bristol Myers Squibb again?, began to rely on that rating to make a 30 year bond a 35 day piece of paper with no liquidity risk…and the issuers went from solid muni’s to muni bond funds and then on to nonprofit foundations like Metropolitan Museum and Deerfield Academy. Without the AAA insurance provided rating these issuers would never have made it to market…especially the muni bond funds like Nuveen who used the leverage to buy more bonds to boost current yields and that is about to change as the market shrinks and they are forced to divest or at least post lower returns…sharply lower.
As for the bailout…it will either mean splitting off the muni side or backing, so far with $1B and $2-3B more to come, the risky collateral like CDS and other derivatives. Will this really help liquidity in the marketplace? No, like all of the plans before this, it only stops the deterioration in liquidity. So should the market rally on this…other than for shortcovering purposes? You decide.
2. LBO’s etc. Some of yesterday’s rally was attributed to private equity coming back into play. If that is the case, it didn’t show up in Blackstone (BX) or hedge fund manager Fortress Group (FIG) as they continue to skid along the lows. Since their IPO in June, Blackstone has targeted 26 companies…don’t know any more details but of the ones who they did buy, how many have done well?…recall the peak was in July! Lenders are not willing to give them money with same ‘covenant lite’ terms. Also, if a project is unsuccessful within a time period…one year?…they have to rebate fees. So don’t expect mountains of this like the one Hellman & Friedman pulled off…by the way they are a really good, reputable company.
3. Visa International. There is a conception that investing in stocks is good as it raises capital for the markets. This is patently false…as unless it is NEW capital all you are doing is letting someone else out, or more accurately of late letting a short term player profit at your expense. When Mastercard (MA) went public on 5/24/06 at $39 a share it rallied to $582 on 12/11/07 or 582%, since then it has declined by 13% from the high, but still 500% is nothing to sneeze at. TB avoided it and it did have a mildly rough start after much hype but never fell below $40 then it was up, up and away. One reason he didn’t like it was the pending lawsuit with Visa which was a major reason for the IPO. That was settled and investors never blinked. Now we have a credit crunch and it became even more popular since credit isn’t involved, merely transactions…make sense, no? Yes, but at a price. The stock si selling at 27x projected earnings and 34x trailing…but the economy is slowing…yes but groceries are now charged and that means more transactions…more smaller transactions at lower fees. Also, the Beta which is now understated is 1.08x so you have 8% more market risk than the S&P 500 and given the historical growth rate of 19.7x (with tighter credit do you expect this to continue?), the P/E to growth rate is 1.35x, getting pretty fully valued that. Dividend? oh, just 0.30% that’s it. Now what about big brother, Visa? Will probably be priced at $37-39 assuming a 27x P/E (same as MA, aren’t they going to leave anything on the table?) and raise $37-42B. How will this be spent? $3 Billion for a reserve for an AmEx lawsuit and $10-12B to the shareholder banks. Think about it: will this money be loaned out? No, it will be used to shore up capital as the biggest investor is JPMorganChase. So while there isn’t a rat’s chance in hell of TB getting in on the IPO…and if he did he would wish he didn’t as you know what that would mean…he is content to watch how it does. Question: if a stock is trading at 27x earnings, just how much dividend can it pay?…and where does the future growth come from? They say Europe…ok. A visa isn’t necessarily a passport to wealth.
4. Hedge funds. We are constantly told that hedge funds are good for the market…some are but as a group TB disagrees. Apparently so does Congress as a study says they may be disruptive largely due to multiple prime broker agreements. This is much worse than with LTCM in 1998 due to the proliferation and the reliance on credit at all levels. Quant hedge funds by the way were down 6% in January. A quick glance at funds of hedge funds showed a decline although not nearly as much as the market. You decide.
5. Friday is not only the 29th (leap year) but monthend and that will have the same effect as options expiry but perhaps even more amplified due to credit and liquidity risks. Therefore it is significant to TB that most of the major indices rallied to the 40 day moving average which most have not seen since 1/2! See summary below for more details and in light of the economic data releases this morning looks like it could well be a case of thus far and no farther. TB has noted over the past 10 years that the 40 day provides major support in a bull market and when we start to fall below it a warning sign which then becomes resistance on the downside. The worst even is when the 40 day crosses below the 200 day as with both Nasdaq indices, the Russell 2000 since early November and before that in late August…there was your warning: SOX has been thus since Halloween with the 40 day providing resistance all the way.
As you all know TB has paid particular attention to the wealth gap which continues to widen. The top 1/10 of 1% have as much wealth as the rest of us combined. If consumption is 70% of GDP, how can this happen without the rest of us spending our way into oblivion. When hedge fund and private equity managers get rich where does that money go? How much of it these days goes into new enterprises when it is so much simpler to buy companies, borrow against them, slash expenses, then take them public again only to flounder? That is the game plan and that may be capitalism but it is not a capitalist ideal.
TB is late this morning but the ideas just kept on flowin’ and you have to go with the flow.
TB
Trader Bill thinks it is clear to anyone reading these missives that they are merely commentaries…as he sees it…and in no way reflect the views of anyone other than himself. Information is gathered from sources he has found reliable, but no guarantees of accuracy are implied. No fee…nothing to sell…merely observations of events in the marketplace offering a non-mainstream viewpoint…sometimes…usually? Hope you find it useful.
Copyright TBD Capital LLC February 26, 2008
