no G.E.! Earnings just came out and it isn’t pretty. TB has had concerns that buying multinationals isn’t the answer…not US based ones anyway…and US based with defined benefit health and benefit plans. Here are some of the highlights:
*Q1 2008 continuing earnings per share of $0.44, down 2%…consensus vs 51 cents, sees Q2 .53-55, analysts had seen 58 cents.
*Shortfall due to financial services earnings on mark to market, and impairments, forecasts Q2 financial services earnings down 5-10% for the year
*Adding to the financial sector weakness vs. rest of economy, infrastructure profit rose 17%, customer service agreements backlog +16%; commercial Finance revenue up 7% but earnings down 20%.
*Industrial revenue up 1%, earnings down 16%, Healthcare revenue unchanged, earnings down 17%
So see it is all financial services…well, not quite: financial services businesses hurt by slowing US economy is what GE said. This will not play well with markets and may be the catalyst for the next leg down TB has been looking for…this will knock the straddles out and the support at $36 is now history, as will be the 40 day moving average at $35.17, setting up a break of $34 which will then test the lows at $31.85. Remember that string of positive earnings surprises under Jack Welch (the house that Jack built), and Immelt has done a good job…some things are simply beyond your control.
This is a perfect segue into TB’s original point of discussion this morning: mark to market and the impact on earnings. Anybody remember recently when Morgan Stanley reported? TB said at the time that much of that had to do with mark to market gains, and warned that while this could put a bottom in for financial services, this was nowhere near the end for the banks who will just keep writing down those bad loans. TB also said never underestimate the ability of Wall Street to find new ways to make money, even if it is illusory as the following illustrates:
Remember the story the other day that Citi was selling $12 billion of leveraged loans…at 90 cents on the dollar and that the buyer would be Black Rock? Well, Reuters and others started delving into the devilish details and guess what? It is not even as good as that 10% hit sounded…this was called to TB’s attention by fellow daily commentator, Joan McCullough. Joanie pointed first a rumor and a then a similar story on Reuters and the word manipulation Immediately comes to mind.
The rumor she reported was that the reason they got 90 cents was that they indemnified the buyers for 20% of the losses ( .90 less .20 equals .70 or about 10 cents above the market bid…got it?…now hold that thought). Then along comes Reuters saying that while the sale “is seen as a positive for the bank and loan market…the deal will leave the largest U.S. bank with exposure to those private equity firms even after the sale.”
If you are now trying to shake the cobwebs out of your brain on that last comment the reason is that Citi is financing much of the sale itself (remember C rallied on the news)…in other words this is not a bonafide arms length sale! The new loans are obligations of the private equity firms. In other words this is an offer you can’t refuse. It goes like this:
Black Bart (ficticious name so don’t think you missed one of those private equity firms), does a leveraged buyout on Maxwell Auto and Pencil Sharpener Company (if you ever watched Jack Benny you will understand this). They negotiate a leveraged loan with Citi or some other equally stupid bank, then take out the cash they can, lay off employees and sell unproductive assets…still with ole TB?
So now, things take a turn for the worse and the banks realize…like the mark in a con game…that they have been duped…any con man will tell you that what they do this for is to see the reaction on the mark’s face when they realize they have been scammed. Uncle Alan…this does not happen unless you have too much cheap money floating around leaving bankers with idle time on their hands to come up with new ways to lose money while Wall Street is finding new ways to use it and lose it!
What to do…a light bulb goes off in the bankers mind and he calls one of those highly paid, lowly taxed private equity geeks and says, “have I got a deal for you.” He then props the following: We will sell you back those leveraged loans we made to Maxwell for 90 cents…see you made 10%. Black Bart sits back and laughs and says, “those aren’t worth the paper they are printed on…pass.” Beads of sweat erupt on the bankers forehead and he says, “wait we will absorb the first 20% of the losses.” Bart sits up in his chair and says, “close but no cigar…see the problem is we don’t have the money right now since you balked on your agreement to fund Clearchannel.”
“Oh come on, let’s let bygones be bygones…how about if you forget the lawsuit on Clearchannel and we will ‘help’ you finance the loans you are going to buy back from us?” Bart is now holding his hand over the phone laughing and wetting his pants. “Let me get this straight…you loaned us…oops, Maxwell…the money so we could buy them…and now you want to sell them back to us for a 10% loss, guarantee 20% of any losses if Maxwell goes belly up which is unlikely because we are smart guys, and then lend US the money to buy back our paper, right? Would you mind putting that in writing and we will have our lawyers take a looks and get back to you. ” CLICK…quickly as he can’t wait to pass this joke on to his partners!
But wait, the best is yet to come because on mark to market rules Citi can now up the value of the rest of their leveraged loans to 90 cents, right? Is America a great country or what. You know that old phrase we finance what we sell,right? You know when the economy turns bad and companies start financing the sale of their products to their customers…don’t sound so shocked furniture stores have been doing it for years…no down, zero percent interest and no payments until 2050…a la you’ll love it at Levitz. So who is really left holding the bag…the shareholders…the ultimate other peoples money.
You do know that it is illegal to put an asset on your books at an inflated value don’t you? Especially for a bank! What have we created. First, business complained that they had to carry their real estate on the books at cost…please let us mark our assets to market…this on the assumption that everything goes up in value forever, right? But now that things are going down and despite the fact that they got the benefit of all that mark to model pricing which is by the way at the margin (if you are getting lost it is the same as a house going for $100k over the asking price thus adding $100k to every place in the neighborhood and as long as the market is strong it is the gift that keeps on giving.
So Jamie Dimon and all the other CEO’s should send nice presents to all the execs at Citi this year because they just cut the markdowns on their leveraged loans and similar assets by 30% or more. That means earnings will look better…’look’ being the operative word. This is much the same as the gains companies are now getting from the value of their debt falling on the abstract concept that IF they were to buy it back it would cost them less…if you think this is a joke remember in 1998-2000 when companies, including GE, were taking into earnings the money that they would have had to contribute to their defined benefit pension plans because they were now overfunded, this despite the fact that they had not even begun to fund their retirees health plans…to it’s credit GE was the first to knock that practice off…some went on for quarters and even years before (this should never have gone into earnings since they could not access the overfunding and instead should have merely been a footnote or less since the assumptions of funding are so flawed as to be laughable…until you realize they aren’t!).
Lastly, and TB dreads to put this in as he has friends at Lehman. You know Lehman, we are not having problems, we are no Bear Stearns…and TB agrees with that assessment. But on the Friday before Bear went down we were told it was an $80 stock. Again, TB isn’t saying Lehman has the same problems but they do themselves a disservice when the CEO says they are doing well and don’t need more capital. THEN, days later he announces they had a $4 billion capital infusion. Joan points out that in a 4/9 filing with the SEC, they reported liquidating three investment funds causing them to take a $1.8B on assets. So what did they do? They created CLO’s out of them which are now eligible as collateral at the Fed with a borrowing cost of 2.5%! This was all reported on Bloomberg and is yet another instance of OPM…this time not just the shareholders…the taxpayers who are now on the hook for this crapola.
Did anyone else think it odd that Merrill’s John Thane said, “we have sufficient captial for the forseeable future?” What does that mean? …as far as the eye can see?…as far as Thane can see? …as far as they want you to see?…as far as they know? It is definitely clear as mud!
Still think this is a good time to buy financial stocks? If you still do, then you and Larry Kudlow should get together for a stiff drink. Last night, Kudlow once again said this is a minor set back and Goldilocks is merely taking a breather…yeah, right Larry, you are not only an ideologue but an idiot!
Hopefully today will not be a Black Friday…but the indications are that if GE, which had been billed as the bellwether, has problems delivering earnings there must be a lot more of them out there.
Just get through the day and go home and relax…can’t wait to read Barron’s!
TB
Trader Bill thinks it is clear to anyone reading these missives that they are merely commentaries…as he sees it…and do not necessarily reflect the views of anyone other than his own. Information is gathered from sources he has found reliable, but no guarantees of accuracy are implied. These are merely observations of events in the marketplace offering in an attempt to offer a non-mainstream viewpoint. Hope you find it useful.
Copyright TBD Capital LLC April 11, 2008
