Monday, September 29, 2008

Check the Fine Print on the Bailout: It Has Some Good News

No one ever gives anything away, not even the federal government.

If you think the $700 billion bailout amounts to a mere windfall for the idiotic risk-management practices of a few, consider: Banks must give the federal government common or preferred stock to participate in the rescue. No CEO wants to be the guy who took "free" money and further eroded shareholder value after an already lousy year, which issuing new shares or preferred would certainly do.

Bear in mind also that the government is actually getting something for your money in this deal: Mortgage-backed securities. Just because these assets are too toxic to trade (right now) doesn't mean that they aren't performing. They are. These assets might not be saleable, but they're still earning money. That's because most homeowners are in fact paying back their loans. The feds will use this cash -- billions of dollars in interest payments -- to either buy more mortgage-backed securities or simply to recoup our investment.

The government's main asset in this deal isn't cash, it's time. It doesn't have to please or at least placate Wall Street like public banks do. Uncle Sam can afford to wait things out -- and I wouldn't be the least bit surprised if the secondary market for these assets reappears. Soon.

I also think you'll start to see ads in the Wall Street Journal in short order from banks advertising the fact that they are NOT participating in the bailout.

Sunday, September 28, 2008

Watch List: National City

So it looks like we have a deal. Policy-makers, doing the job they're paid for, have created a compromise plan to bail out financial markets.

The rescue is too late to save Washington Mutual, which was seized late Thursday by federal regulators. That news sent its stock to the floor. It also did a number on Ohio-based National City.

NCC lost -25.7% Friday to close at $3.71. The shares have traded between $2 and $27.21 for the past 52 weeks. Shares are down -77.5% year to date. I think they're a buy. Here's why:

(1.) Banks make money by lending. That's also how they lose money. NCC's "classified" loans total $3.7 billion, or about 3.2% of NCC's total. These are credits more than 90 days past due.

Every bank has classified loans, even in the best of times. To cover these losses, bankers set aside cash in a reserve fund. NCC's loan-loss reserves, according to the latest data from the FDIC, total $3.4 billion.

Not every classified loan will go bad. In fact, the FDIC's Quarterly Banking Profile for the period ended June 30 says the net chargeoff rate for banks with more than $1 billion in assets was 1.32%. NCC's reserves are higher than that -- it can cover 3% of its loans, or 92.6% of its classified loans. So if every classified loan goes bad, NCC will need to come up with $316 million to cover them.

National City can do this very easily: The upside to having 3% of your portfolio classified is that 97% is not. Those loans are still earning interest. Consider: $112 billion at 8% earns $9 billion a year in cash. Even if the cost of funds behind those loans -- what it had to pay to borrow the money to lend it -- is 5%, or $5.6 billion, then NCC is still turning a gross lending profit of $3.4 billion, and that's before it earns a dime in fees.

(2.) National City has no option-adjustable mortgages on its books. These loans allow borrowers to pay less than their full monthly interest payment, and they've caused banks no small amount of consternation. Anyone worried that NCC is the next WaMu should write this down: WaMu's option-adjustable mortgages alone were larger than NCC's entire mortgage portfolio. WaMu made billions in loans and let borrowers pay no interest. Smart move? You be the judge.

(3.) NCC has a huge stake in Visa it could sell to raise cash -- in fact, it has very strong assets. And they're selling for very cheap -- NCC is trading for a fifth of its tangible book value. Its market cap is $2.9 billion. From a purely fundamental perspective, this bank strikes me as being worth more than that -- and that was true with or without a bailout.

Those are all good reasons to buy these shares. But this is a market where good reasons won't get always you very far. Nevertheless, NCC presents a potentially good short-term trade: Assuming a sub-$4 entry point, I like the idea of a laddered exit prices of $4.75, $5.50 and $6.25 covered by a trailing stop to contain downside. Granted, that's academic if the shares open at $8.25, and that's not out of the question as Wall Street responds to the bailout. With any luck, it won't be signed into law until Tuesday, and National City will drop back down to $2 in the interim. Hey, I hate to be a greedy bastard, but I do have an obligation to shareholders.

A rising tide lifts all boats, and the bailout is sure to bring back investors who sold off on Friday. We'll see…

Sunday, September 21, 2008

The Case for Netflix, Part 1

Boss Hoover smelled trouble.

The automobile was on the rise, and Hoover he knew it was only a matter of time before his profitable Ohio saddle shop would go on the wane. His sickly tinker of a cousin, James Murray Spangler, had recently taken out a patent on a gizmo he'd invented to help him clean the department store where he worked. Hoover bought the rights to the machine in 1908 and went on to make the vacuum cleaner an essential household tool.

True story.

Hoover had the vision not only to foresee that his saddle shop would falter but also to exploit a new technology. When I think of Hoover, a similar episode comes to mind. In this case, a company that remade a failing industry, then lassoed a developing technology to enhance its strong competitive advantage and position itself to dominate its market.

That company: Netflix.

I'll soon begin a series about this company, which has proven adept at seeing the future and profiting from it. The video-rental company, which mails movies to customers on a subscription basis, foresaw the widespread adoption of the DVD and then revolutionized the way America rents movies, much like iTunes changed how people buy music (and how Amazon's Kindle will change how people buy books).

Netflix took everything that was wrong with conventional movie rental and leveraged it to its advantage. It countered the inconvenience of a round trip to the video store with
free home delivery and return. It didn't just eliminate late fees, it gave customers total pricing control. It built a vast library of movie titles that no brick-and-mortar competitor could match, and then it developed a proprietary system for suggesting movies for its customers. You don't need a membership card. You don't need cash. You don't even get a bill -- payment is automated.

Have you ever met a brand ambassador? Someone so sold on a product that you can't get him to shut up about it? Some people feel this way about their iPhones or BlackBerries. The zeal of the Netflix user comes close.

And, in that vein, the only figure I could find that was higher than Netflix's customer satisfaction rate was the performance of its stock. The company incorporated in 1997 and sold shares to the public in May 2002 for $7.72. They now trade for $32, a gain of +314.5%.

Hoover saw the writing on the wall about the advent of the automobile, and he realized the potential of his janitor cousin's contraption. Netflix, similarly, foresaw the adoption of the DVD and had the vision to change the way people could rent movies. And it is doing it again. Netlfix knows video-on-demand is next. And the company has begun to position itself as a market leader of this new technology. As competitors like Blockbuster are scrambling to catch Netflix in rental by mail, Netflix is partnering with manufacturers to build set-top boxes that will allow downloads on demand. Netflix's real revolution -- and real financial performance -- hasn't even started yet.

I'll lay out my case for this longterm play over the next few days. Stay tuned.

Thursday, September 18, 2008

Closing MER

I sold all my MER shares for $27.05 about an hour into the trading day.

I bought this stake on the premise that the firm was undervalued on Aug. 1. I still think it is, but that just means Bank of America got a good deal, not that a better offer is possible.

I paid $26.85. As Merrill began to slide last week it dipped my "floor" price, and I doubled down at $19.43. Over the weekend, when everyone -- including me -- expected, BAC to make a run for Lehman, it instead bought Merrill for $29 a share in an all-stock deal worth $50 billion.

BAC subsequently took a little hit, so MER's shares didn't rise to the merger price, as is typical in cash deals. The stock has since seen extreme volatility.

I may well have sold too early, but trying to buy every bottom and sell every top is a fool's errand. Sometimes brass means having the presence of mind to walk away with a profit.

And I did, ahem, make +16.9% in 49 days, and that ain't bad.

The Successful Investor

Last night I ate at a barbecue joint. I'm fond of this place. They don't have plates and you sit at metal folding chairs around long tables that both remind me of the parish hall of the church I attended as a kid. It's a family place where families eat. I held the door open for the woman behind me. Wouldn't have seemed right if I hadn't. That kind of place.

I typically eat with an exceedingly literate and well-informed companion -- The Wall Street Journal. The paper's news was exceedingly grim. I pushed it aside and sat back to think about the day. Friends had called and emailed to ask what I thought, what they should do. Some I told to do nothing. Some I told to start buying. The right thing to do in this market is what you feel most comfortable doing.

Come to think of it, that's the right thing to do in every market.

We're hearing a lot about the business of risk these days. It's been around for centuries, but now it's on page one. We hear the people on the news try to say "credit default swaps" and "delevering" as though they've been saying them for years. They haven't been, of course, and they're clearly not comfortable with the terms.

But you don't have to understand these terms to be a successful investor.

You do have to understand what the term successful investor means.

It doesn't have anything at all to do with beating the Street, earning X return or timing the market. It's wholly unconnected from your account balance. Being a successful investor means you can sleep at night. It means you've put your money into securities that you understand and have confidence in -- and that's the sort of advice I try to give. And when the financial waters roil and the Journal prints articles vaguely suggesting an imminent financial apocalypse, what do you do?

Well, I went to eat barbecue and watched a little baseball on TV.

Treasury Secretary Hank Paulson and Fed Chair Ben Bernanke, among others, aren't getting a lot of sleep or time off these days. Nor are their counterparts in Japan, England and the rest of the Group of Eight. That's as it should be. Together, those men and nations have the tools to stave off a meltdown -- not a crisis, but a meltdown -- and the smart move is to sit still and give winds and tides time to change.

That's my take, and this: A weekend off is going to do a lot of good.

In the meantime, I'm doubling down on CIT.

Thursday, September 11, 2008

"It Was Funny the First Time" Dept.

Citigroup downgraded embattled Lehman Brothers today, from "buy" to "hold."

As with its recent move to remove its "buy" rating from failed Fannie Mae and Freddie Mac, Citi's Lehman downgrade not the most prescient call. After all, Lehman shares have lost -92.5% for the year. Was this is first time it thought, "Yunno, this might be a good stock for our customers to get out of."

Upgrading Lehman from "buy" to "strong buy" actually would make a lot more sense. Heaven knows I'm tempted to grab some of this storied company at this insultingly cheap price.

Wednesday, September 10, 2008

"Yeah, But You Heard It Here First" Dept.

Banc of America Securities upgraded its view of American Eagle Outfitters shares from "neutral" to "buy."

Analyst Dana Cohen credited "offensive" promotions (I presume that means "aggressive") and conservative inventory management. Her new price target is $20.

Monday, September 8, 2008

"Gee, Thanks a Lot" Dept.

The genuises at Citigroup and Lehman Brothers downgraded Fannie Mae and Freddie Mac this morning.

What makes this particularly egregious is not that this downgrade is so obvious, it's that Citigroup had a "buy" rating on both companies. Lehman rated them "overweight."

That's like saying it might not be a good idea to buy a ticket on the Titantic's next voyage -- after she had already sunk! "Tulips? Yeah, they look like a pretty good investment to us, duh..."

Not everyone on Wall Street was so bloody stupid. Merrill Lynch, for one, was at least neutral. That's a defendable position. Neutral means, "We'll see." But a buy is simply inexusable, and a serious blow to both outfit's already reduced credibility.

Friday, September 5, 2008

I Love the Smell of Opportunity in the Morning

The unemployment numbers this morning didn't help anything, and Wall Street is taking it on the chin. For serious investors, though, it's time to quit whimpering, get off the damned sidelines and start looking at the down market as the good thing it is.

The stocks I've chosen haven't plunged, but they've given back some of their gains. So if you failed to heed my advice on these companies, now is a great time to correct your lapse in judgment.

Consider this market's aggregate buying opportunities. Of the 30,000 or so equities that trade on U.S. exchanges, 4,000 of them are down more than 40% so far this year. That's almost as good as the end-of-season blowout at the Polo store -- and some stocks have declined to the point where even that sale looks pricey.

These drops hurt. I understand that. I've had friends retire as the market bled, and that's noting to make light of. Certainly I remember what 2001-2003 felt like. But Wall Street always bounces back after a decline. (See the S&P performance table in Buffett's annual shareholder letter.) And if the market fails to bounce back, then, hell, your portfolio is the last thing you need to worry about.

The Dow shed 344 points yesterday and is off another 100 points as I write this. I'm not at all concerned. I feel like Gen. George S. Patton Jr., strolling through enemy territory on a French battlefield in World War I, dodging shells as I check my beloved tanks' progress. Just a nice night for a walk...

Those tanks, the eight stocks in my portfolio, have held up extremely well during this past two-day drop. In fact, they remain in positive territory. They are up an average 2% since I bought them last month versus a drop of more than 3% for the S&P. This gap is only going to get wider, as investors come around and begin to see the true value of these outstanding companies.

Thursday, September 4, 2008

Two Stocks on Sale

I took a spin through the bargain bin this morning to see if any interesting companies had hit 52-week lows. I love doing this.

Here are two I like:

The glassmaker is trading at less than five times earnings. It cut its 3Q profit outlook and Wall Street couldn't sell Corning fast enough. Shares fell the most they had in two years. But here's what the company said: Earnings per share (ex items) will be between 43 cents and 45 cents a share on sales of $1.58 billion to $1.62 billion.

Hmm. Those look like decent numbers to me, especially when you consider that its previous forecast was a profit of 48 cents to 51 cents on sales of $1.65 billion to $1.72 billion. Even the worst-case revenue number is better than last year. Lots of companies would be thrilled with just being able to use that color of ink.

Shares closed Friday at $20.54 and are currently at $16.75., a drop of 18.4%%. Even if profit comes in at the low end of Cornings' revised guidance, that still only a decline of 11% on the bottom line. The market has overreacted to this news, and this presents a good buying opportunity.

iShares MSCI Taiwan
I recently wrote about Harvard Management's Co.'s addition of 7.2 million shares of iShares Taiwan, a stake worth $102 million and equal to 3.2% of Harvard's publicly reported portfolio. Shares of this exchange-traded fund (Ticker: EWT) are at their 52-week low.

Not surprisingly, the market this ETF tracks is also in the toilet, having lost 24.6% so far this year. It is also at its 52-week low.

Now, lest you think I'm recommending a purely "technical" move, let me add this: The TAIEX is trading at 10 times earnings. Taiwan is expected to post 4% annual growth through 2012. The Standard & Poor's 500 Index, the U.S. benchmark, is trading at 25 times earnings -- and we're only going to see 2.5% annual growth through 2012. Taiwan is cheap, and this ETF is a shrewd play.

An exchange-traded fund acts like a mutual fund but trades throughout the day like a stock. It's a great way to participate in the Taiwan market, which you otherwise wouldn't be able to access without a bunch of hassle and a shitload of fees. You can buy EWT using a discount broker like Scottrade.