Tuesday, November 4, 2008

Jacobs Engineering (JEC) - Business as Usual

We don't own any of these global engineering stocks at this moment, because effectively the market has chased us out of the names. We closed out of Jacobs Engineering in early September in the mid $60s; within 6 week it had fallen below $30. It is really quite sad to see the stocks performance when you consider how the best of breed are still performing "business as usual". The problem with owning these now is you have "reality" 1 day a quarter (when they report earnings) then rumors and innuendos of lost contracts, cancelled business, blah blah blah every other day of the quarter. As tempting as it is to buy these now, it won't take long for the bad economic news to come back to the forefront and calls of global slowdown to punish these type of stocks. But they were so oversold they had to bounce at some point. But unless your timing is perfect it is near impossible to make money on the long side - even with today's tremendous move and the past week's great action the stock is only back to where it was 2 weeks ago. If you have a 5 year time horizon these prices should be a highway robbery but for the next 6-9 months the whole complex is still iffy based on perception more than reality. Earnings were solid as always - revenue up 41%, earnings up 36%, backlog continues to grow (bears will say all these contracts can be cancelled at any second, and everything gets cancelled sub $60 oil anyhow) despite a dispute with a large Canadian customer...

Fluor (FLR)
and Jacobs Engineering (JEC) continue to appear to be best of breed although some of the other names are even cheaper - KBR (KBR) for instance has been trading below cash for parts of the past two weeks - quite pathetic. For traders, a stock like JEC could potentialy trade back to its 50 day moving average of $49 but I'd consider it, in the current market, a short from there as "worries" will be "resurface" about the global economy soon enough. But that's still a 20% upside trade with a tight stop below $38.50 for those who are jumping in and out of stocks on a very short term basis. I'd rather buy it when I can hold onto it for a few quarters in a row without experiencing the -15% down days we get the pleasure of experiencing in this group on a now almost weekly basis.
  • For the fourth quarter of fiscal 2008, Jacobs reported net earnings of $114.4 million, or $0.92 per diluted share, on revenues of $3.2 billion. This compares to net earnings of $83.9 million, or $0.68 per diluted share, on revenues of $2.3 billion for the fourth quarter of fiscal 2007.
  • Jacobs reported today record net earnings of $420.7 million, or $3.38 per diluted share, on revenues of $11.3 billion for its fiscal year ended September 30, 2008. This compares to net earnings of $287.1 million, or $2.35 per diluted share, on revenues of $8.5 billion for fiscal 2007.
  • Jacobs also announced backlog totaling $16.7 billion at September 30, 2008, including a technical professional services component of $8.1 billion. This compares to total backlog and technical professional services backlog of $13.6 billion and $6.2 billion, respectively, at September 30, 2007.
CEO Comments
  • CEO Craig L. Martin stated, "In spite of significant challenges created by the recent hurricanes in the Gulf Coast, our team produced excellent results in the fourth quarter and for the year.
  • Our one disappointment this quarter came from a breakdown in our relationship with a customer on a project in the Canadian oil sands. Because of the breakdown, the customer is transferring future phases of the project to other contractors. As a result, we removed $2.36 billion from our backlog for this project, which would have been performed over the next three fiscal years. Of this, $2.27 billion was in field services, substantially in the form of 'pass-thru' revenues. Our Canadian business remains healthy and we are working diligently to rebuild our relationship with this customer."
  • "Our sales in the fourth quarter remained strong. Our business is solid and prospect quality remains high. As we look ahead, FY09 looks like another good year."
2009 Guidance
  • Commenting on the Company's earnings outlook for fiscal 2009, Jacobs Chief Financial Officer John W. Prosser, Jr. stated, "The outlook for 2009 is good and should track inline with our long-term goals. Our initial guidance for 2009 earnings per share is a range of $3.55 to $4.05." (analysts at $3.99)
No positions

Solar Setting Up for "Sell the News" Rally

I always find it interesting to see human emotion swing so rapidly - the switch from fear to greed can be almost instant. I also find it interesting how traders can use a foregone conclusion ("Obama is gonna win!") as a reason to drive a group up - in this case the solar stocks. The whole group has been on fire the past two days but if you take a step back and put it in perspective - they are back to where they were 3 weeks ago. But if you caught the exact bottom you could of made 100% in a week or so on many names. If you were a week or two early you are basically flat. They are that volatile. These were getting hammered on their high needs for capital to fund business operations along with their customers potential lack of access to capital - not much of that has changed. But perception changes and the "Obama" victory will change everything overnight - even though 95% of the solar market is outside the U.S. Also, did it just become clear Monday morning that Obama would win?
  • Solar stocks today have extended yesterday’s torrid rally, apparently getting a boost from investors anticipating that a victory today for Democratic presidential candidate Barack Obama will be good news for the alternative energy business. But before you jump in, you might want to think for a moment about what will actually transpire - and on what timetable.
  • While it may be true in the long run that an Obama presidency will be good for solar shares, a change of administrations will not be a cure-all. Raymond James analyst Pavel Molchanov this morning cautioned that investors should not expect any “instant gratification in terms of new goodies from Washington,” especially given that Congress has already approved an 8-year extension of the solar investment tax credit.
  • “We agree with the general premise that an Obama White House/Democratic Congress combination sets up the prospect for a greater amount of federal action on the renewables front than would be the cae under Senate McCain,” Molchanov writes. “However, we do not envision immediate action (within, say, the first 100 days) on these issues. To put it bluntly, while solar and wind are important, there are much bigger things on the plate that policymakers in the U.S. are understandably focusing on within the context of the global financial crisis.”
  • Several analysts have written bearish commentaries on the solar stocks over the last couple of weeks, citing the negative implications for the solar business of the rally in the dollar and tightening credit markets. And while the bears can’t be too happy today, don’t lose sight of the fact that most solar companies get the vast majority of their business from Europe; it will take a big yet-to-be-created program to drive U.S. solar installations high enough to offset the expected near-term weakness in Germany and other European markets.
None of it makes much sense, but sentiment is sentiment - you just never know when the market turns its attitude - we were buying these at anywhere from 4-8 PE ratios and they fell to 2-5 PE ratios. Kind of silly they ever fell so much, and just as silly they rally on "Obama" but traders don't care about such things - they just want a hot thing to play. I put the chart for ReneSola (SOL) below as one example of the casino action - basically these are setting up for a "sell the news" reaction in my opinion within 1-2 sessions.

One thing that is typical, is analysts downgrading these stocks at the bottom as we saw on Oct 30th, Oct 31st, and Nov 3rd. I don't have an issue with the "reasons" for these downgrades but when stocks are trading at 2-3x earnings I think most "worst" case scenarios are priced i.e. when earnings can in theory drop 50% in 2009 from 2008 levels and the stocks still trade at 4-6x earnings it appears you are a bit "late to the game" in your "downgrades". But analysts are nothing if not consistent.

I still like LDK Solar (LDK) and ReneSola (SOL) as "arms suppliers" to the module makers but as we've been saying for a long time this is going to be a cut throat, highly commoditized end market and this credit crunch is going to winnow the weak much quicker than I anticipated. [Jan 3: The Long Term in Solar] But in *this* market where people do not differentiate it has not helped to be in 1 subsegment of solar over another - they are either "all bad" or "all good". That has been typical of every sector of late - homework on individual companies has been useless.

There is one piece of good news in a sea of bad of late... polysilicon prices seem to be falling hard now that the semiconductor business is having so many troubles.
  • Polysilicon prices are falling rapidly, thanks in no small measure to a serious slowdown in the chip sector. And that’s good news indeed for solar companies.
  • Dan Ries, an analyst with Collins Stewart, reports today that polysilicon prices have declined about 20%-30% over the past three weeks. In a research note, he says that prices for high purity polysilicon are down about $100/kg to about $300/kg.
  • Ries notes that he has been expecting a drop in poly pricing by mid-2009, but that it is hitting sooner than expected due to the slowdown in the semiconductor business, the other major consumer of poly supply. Ries thinks the semi industry will use 20%-30% less poly in Q4 than in Q3, freeing up more supply for the solar industry.
  • Write Ries: “This decline is a welcome relief for module makers as it will help to offset the sharp reduction in ASPs expected in the quarters ahead due to the Euro.”
I continue to sell almost all we have left in solar into this rally. The stocks are still cheap on a fundamental basis, but the moves have been enormous - and most of the Chinese solar stocks report in the coming two weeks and I expect a lot of mixed news. We'll see if this move lasts past Thursday as traders exit. That said, the animal spirits are now high again so a lot of cheap, more riskier type of fare is moving rapidly in this market; solar stocks are the high beta group that are representative of this.

Long LDK Solar, ReneSola in fund and personal account

NuVasive (NUVA) in Investors Business Daily

Screening through charts of positions, there are a few names now back over their 20, 50, and 200 day moving averages - NuVasive (NUVA) is one. I don't see any news in particular but a nice article in Investors Business Daily from late October I thought I'd bring here; I always like their stories because they usually can explain some more complicated fundamental stories in "layman's terms".

The stock market action (aside from yesterday) continues to be "student body left" or "student body right" - everything is good or everything is bad trading. While it feels better to the upside then downside, it is not really an investing atmosphere when individual stocks continue to not differentiate and everything has to be either bought or sold en masse. I will be interested to see the markets reaction later this week to retail numbers and the jobs report...

Still trying to find a leadership group if there is any sustained move up - right now the most oversold stocks are simply reverting to a mean but nothing has been consistent - I still have hopes that healthcare should be one group that works over a longer period since it should be relatively immune to a recession. NuVasive has my favorite business model - razor and blade - sell the razor once, sell the blades forever. Unfortunately there are a lot of legal expenses hitting due to a patent suit, but that's not an operational issue - just a cost that is a pain to maintain.
  • In a stalled economy, investors might be rightfully concerned about weak spending for high-ticket capital gear. That's certainly been a concern for followers of medical-equipment stocks. Some might lump medical-device maker NuVasive in that boat. That would be unfair.
  • Most of NuVasive's (NasdaqGS:NUVA - News) sales are from dozens of small disposal tools and grafts used to perform a minimally invasive lateral back-fusion surgery it developed with specialists. Analysts say the economy doesn't much matter when it comes to back surgeries. People in pain don't want to put off procedures, and reimbursements don't stop when the economy does.
  • "By the time people make a decision to have this spine procedure, they are already in such pain it's not something they can delay for economics," said Joanne Wuensch, an analyst with BMO Capital Markets
  • NuVasive's year-over-year sales have grown 50% to 65% the last eight quarters. Though sales have been growing in double digits, profits are another story. Investments in new products, surgeon education, new sales reps and technology have kept the young company in the red.
  • Though it doesn't consider itself a big-ticket capital equipment company, NuVasive does make a costly software-driven nerve avoidance navigation system that enables surgeons to perform its unique spinal-fusion surgery. The company gives those units away to hospitals to encourage them to adopt the minimally invasive procedure, since it helps spur sales for its disposable products. Each procedure generates $1,300 to $1,700 from disposable products, the company says. Surgical instruments add $500 to $900. The implants and biologics that are needed to complete each procedure generate even more -- almost $11,000 per procedure.
  • The novel lateral procedure involves making small incisions in a patient's side rather than larger ones in the back or front. Recovery time is shorter since surgeons don't have to cut into much muscle or bone, and costs are lower.
  • As more physicians are trained to perform the operation, NuVasive stands to gain added revenue. Almost 2,000 surgeons have been trained to perform the lateral surgery.
  • One key new product line comes from the July acquisition of the biologics product line Osteocel -- bone-marrow grafts used in spine-fusion surgery. NuVasive said Osteocel would add $28 million to 2009's top line. Osteocel kicked in $4.4 million in the third quarter.
  • NuVasive expects its expanded biologics division to generate $100 million in revenue annually in the next several years.
  • NuVasive's introduction this month of a next-generation nerve-avoidance system -- NeuroVision M5 -- also will help generate new revenue, analysts say. The new system allows surgeons to navigate further up the spine to the neck area so that they can perform minimally invasive cervical procedures as well. The M5 "is a big deal," said analyst Jose Haresco of Brean Murray Carret. "The NeuroVision has already been out a few years, and it needed an upgrade." "This moves us another three years ahead of our competitors," he (CEO) said in a phone interview.
  • Competition in the $7 billion worldwide spine market is intense, dominated by Medtronic's (NYSE:MDT - News) Sofamor Danek, which has about 50% market share. Other larger players include Johnson & Johnson's (NYSE:JNJ - News) DePuy unit, Synthes and Stryker (NYSE:SYK - News).
  • Lukianov says the Osteocel grafts give his firm an edge over medical-equipment giant Medtronic because they sell for about half the price of Medtronic's version.
  • Haresco wrote in a client note that smaller, more specialized players such as NuVasive and Kyphon have been taking market share from their bigger rivals. Lukianov says NuVasive holds 6% market share in the U.S., up from about 4% last year. Almost all of NuVasive's sales are in the U.S., but Lukianov says the company plans to expand next year in key markets in Europe and Asia.
  • Meanwhile, some analysts are concerned over legal expenses from a patent infringement lawsuit brought by Medtronic on some of NuVasive's products. In the third quarter, NuVasive spent $600,000 in legal expenses to defend itself and officials say they expect to spend $1 million in the fourth quarter and $4 million to $5 million in 2009.
[Oct 23: NuVasive Earnings]
[Sep 2: Initiating NuVasive Position]
[Jul 25: NuVasive - At What Price Growth? It Seems "Any"]

Long NuVasive in fund; no personal position

Mastercard (MA) Trounces Earnings

We are long Mastercard (MA) but apparently not enough - post earnings the stock is flying 14%. The stock gapped up through its 20 day moving average ($151) and it's next test should be $180 or the 50 day moving average. MA has been "fortunate" enough to be one of the biggest hedge fund liquidations. While U.S. credit spending should suffer some in the recession, and Visa (V) is a bigger beneficiary of debit cards, the move from "cash to plastic" in most of the rest of the world is still in its infancy. That fact is many times lost when this stock sells off. Some cautious forward guidance here but it's not the news, but the reaction to the news that matters - and some of these stocks have been pricing in global catastrophe - so anything short can now be rewarded. Pretty healthy action today but I'm not really going to chase stocks up here.
  • MasterCard Inc (NYSE:MA - News), the world's second-largest card network, posted better-than- expected earnings on Monday, excluding items, boosted by a strong revenue growth outside the Unites States and currency fluctuations. The Purchase, New York-based company reported earnings excluding charges of $322 million, or $2.47 a share. Analysts on average expected earnings of $2.22 per share, according to Reuters Estimates.
  • Revenue increased 24 percent to $1.34 billion, boosted by double-digit growths in Asia-Pacific, Europe and Latin America. In the United States, where MasterCard generates around 40 percent of its transactions, revenue grew only 4.7 percent.
  • In addition, transactions processed increased 13 percent to 5.4 billion, while the gross dollar volume transactions rose 12.3 percent to $662 billion.
  • But Chief Executive Officer Robert Selander said MasterCard expected revenues to grow below the company's long-term target of 12 percent to 15 percent in 2009 amid a fast deterioration of the world's economy. "We are in an economic crisis like I don't think we have seen in our lifetime," Martina Hund-Mejean, chief financial officer, said in an interview with Reuters.
  • Hund-Mejean said MasterCard felt a sharp deterioration of the world's economy in October with a sudden slowdown of cross- border transactions and forecast the economic downturn would be widespread, from the United States and Europe to emerging markets in Asia-Pacific and Mexico.
  • During October, cross-border volume growth was in the high single digits, compared with the 18 percent growth achieved in the third quarter. The marked slowdown is a direct result of Americans cutting back on their travel spending, he said.
  • The slower economic growth together with a recent appreciation of the U.S. dollar -- which lowers revenues from abroad -- is expected to hammer MasterCard business next year. "We are planning on a more prolonged downturn rather than something turning around in the next three to six months ... My main concern is how long this is going to last," Hund-Mejean said.
  • She added the company forecast operating expenses would remain flat in 2009, as MasterCard is reducing spending in contractors, suppliers, trips and cutting frozen jobs.
  • "I think people are going to be happy with their results," said John Williams, a research analyst at Macquarie Capital. "It is somewhat a sigh of relief for people. They thought the world was ending and clearly it is not."
[Jun 9: Mastercard, Visa see Gold in PrePaid]
[Apr 29: Mastercard Continues to Impress]
[Jan 31: Mastercard Continues to be Priceless]
[Dec 7: Mastercard to Benefit from Visa IPO Hype]
[Oct 31: Bravo Mastercard]

Long Mastercard in fund; no personal position

Monday, November 3, 2008

Bookkeeping: Selling some Kendle International (KNDL) and Solar

Not sure why solar stocks are up 20% across the board today but all 3 of our issues are up 15-20% so we're taking more profits here. Wish I had waited with some of the solar selling we did last week. Maybe an "Obama" victory is being priced in but that seems silly to move these stocks up.

I bought Kendle International (KNDL) Friday on anticipation of earnings report and oversold condition - a 20% run would of been a nice, but I expected that over a few weeks. Today we are up nearly 17% so basically the target has been hit before earnings; I'm going to cut back 1/3rd of the position since the opportunity is offered. Kendle drops from a 3.2% stake to 2.1%. But the name is STILL far below any meaningful resistance area.

I also took a bit off A-Power Energy (APWR) this morning up 10% as it appears to now trade with the solar stocks all in 1 complex.

Long all names mentioned in fund; long A-Power Energy in personal account

New York Times: Debt Linked to Buyouts Tighten the Economic Vice

Before the main story there is an excellent (but lengthy piece) in the New York Times 'From Midwest to MTA, Pain from Global Gamble' which outlines some examples of the interconnections of the global finance eco-system; and current fallout. It actually parallels the exact same situation many individuals in America were faced the past decade - facing a shortfall in budget people "got creative" to fill the gaps - and "enablers" were ready, willing, and able to sell them the product to get them there. Granted the enablers are paid on volume of transactions only so if they blow up after the fact - who cares? No different than mortgage brokers the past half decade. It's a long story but thought I'd highlight it since it shows you how even local school boards were taking this gamble to make up for holes in their budget. And why I have been saying for the past year, that next budget year for state's is going to be a disaster (look for federal bailouts there too starting next summer)
  • During the go-go investing years, school districts, transit agencies and other government entities were quick to jump into the global economy, hoping for fast gains to cover growing pension costs and budgets without raising taxes. Deals were arranged by armies of persuasive financiers who received big paydays.
  • But now, hundreds of cities and government agencies are facing economic turmoil. Far from being isolated examples, the Wisconsin schools and New York’s transportation system are among the many players in a financial fiasco that has ricocheted globally.

But the main story I want to focus on is private equity which were about 18 months ago the new golden children - masters of the universe; the best, the brightest, the new power brokers in our era of cheap credit and looking the other way while they load the companies they buy in debt while running off with huge paydays. So for their self interest they are effectively bogging down company after company and threatening the jobs of many in this country. The fallout will be even more apparent in the current credit situation. I still to this day, on principle alone, won't buy Burger King (BKC) stock based on this story I read in BusinessWeek a few years ago [BusinessWeek - April 10: Where's the Beef?] I'm not the only one [Nov 19: Cramer Goes off on Private Equity] The irony is the IPO of Blackstone (BX) effectively put in the "top" in private equity. But let's see how the credit crisis is affecting our friends...

  • Private equity firms embarked on one of the biggest spending sprees in corporate history for nearly three years, using borrowed money to gobble up huge swaths of industries and some of the biggest names — Neiman Marcus, Metro-Goldwyn-Mayer and Toys “R” Us. [That Mervyn's thing didn't work out too well - Jul 21: Add Mervyn's to our Growing Litany of Retailer's Heading to the Great Sunset]
  • The new owners then saddled the companies with the billions of dollars of debt used to buy them. But now many of the loans and bonds sold to finance the deals are about to come due at the worst possible time. So, like homeowners with an adjustable rate mortgage that just went up, some of private equity’s titans are facing a huge squeeze. And that is coming at the same time consumers are staying home with their wallets closed. “There’s absolutely going to be a lot of pain to go around,” said Josh Lerner, a professor of investment banking at Harvard Business School. “The big question is how apocalyptic it will be.”
  • Private equity firms, which are lightly regulated, use investors’ money to buy undervalued public companies and take them private. The difficulty of companies that have been acquired by private equity firms to get new credit could have enormous implications for the economy. People who work for companies owned by private equity firms could lose their jobs as firms cut costs to meet their debt obligations.
  • Pension funds and college endowments that invested their money into in these funds in recent years hoping for big returns are likely to suffer as well, and many of those investors could face a cash squeeze, as they are forced to hold onto their investments for years until the economy recovers.
  • When the economy was booming, the firms made huge profits by cutting costs at their new acquisitions, improving operations and then turning around and selling them. In 2007, at the height of the bubble, such deals totaled $796 billion, or more than 16 percent of the $4.83 trillion in all the deals made globally that year, according to data from Dealogic.
  • Firms like the Blackstone Group and Kohlberg Kravis Roberts & Company, faced an image problem at the height of the bubble for excessive compensation and beneficial tax treatment, but their returns were so high that even investors like pension funds were drawn in. Now these firms, built on enormous amounts of debt, are being forced to go back to the financial markets just as those markets have nearly frozen up.
  • If history is any guide, the worst may be yet to come. Steven N. Kaplan, a professor at University of Chicago Graduate School of Business, found that nearly 30 percent of all big public-to-private deals made from 1986 to 1989 defaulted. Many industry insiders and analysts contend that companies backed by private equity will not suffer nearly as much as those in the late 1980s because the firms pushed for better financing conditions that allow them to keep operating even if they cannot make their debt payments. Stephen A. Schwarzman, chairman of Blackstone Group, remains committed to the future of private equity. “The people rooting for the collapse of private equity are going to be disappointed,” he said. While some companies may find themselves in trouble, he said, many more will be able to ride out a downturn in the economy because of the less restrictive financing conditions that banks agreed to earlier
  • Shares of Blackstone are hovering at around $10, down from the $31 they were at when Blackstone went public in June 2007. (Fortress Investment Group, another big firm, is trading at $4.90 a share, down from its initial price of $35 in February 2007.)
  • Mr. Lerner, of the Harvard Business School, said that trouble among private equity firms would probably “precipitate hard questions about the compensation and fee structure” in the industry. The firms generally take fees of 2 percent of all money managed and 20 percent of profits. “I would not be surprised if they try to head off the criticism by returning capital,” he said.
  • The problem for the past deals is that many firms waded into economically sensitive sectors like retailing and restaurants. Firms like Apollo, Cerberus Capital Management and Sun Capital Partners purchased several troubled companies to turn around from 2004 through the first half of 2007. In the case of Linens ’n Things, a longtime also-ran to Bed, Bath & Beyond, Apollo knew that it had a tough job ahead of it, yet it still added heavy debt. Two months before Linens ’n Things was acquired, it reported $2.1 million in long-term debt; by Dec. 31, 2007, that amount had exploded to $855 million. (sounds identical to the Burger King story) We highlighted Linens n Things in [Apr 11: This Day in Bankruptcies - Another Airline and our First Major Retailer]
  • At the time, private equity firms assumed that they could refinance their portfolio companies’ debt cheaply. But many appear to have been blindsided by the size and severity of the credit market meltdown, which has left lenders unable or unwilling to provide more money. In what seems a worrisome trend, many bonds of private equity-backed companies have recently plummeted in value, signaling worries about their solvency.
  • The bonds issued by Harrah’s Entertainment, for example, were trading at 16.5 cents on the dollar, indicating investors’ belief that the company was drawing closer to a potential default. Harrah’s, too, was saddled with a lot of debt when it was taken private. A month before the completion of the Harrah’s takeover, the company reported $12.4 billion in long-term debt. By June 30, that figure had swollen to $23.9 billion. Harrah’s has already begun making selective staff cuts and has begun scaling back costs, even cutting back hours in its V.I.P. lounge and the complimentary rooms and meals for its best customers. (again the same pattern as Burger King)

UK Telegraph: Investors Shun Greek Debt as Shipping Crisis Deepens


Thanks to a reader for emailing this story to me, which follows up on the Friday story we posted [Oct 31: Bloomberg - Credit Tsunami Swamps Trade] For whatever reasons many shipping companies are Greek based, and the historic drop in the Baltic Dry Index has been used as a proxy indicating a coming (current) global recession.
  • The Baltic Dry Index measuring rates for coal, iron ore, and grains, and other dry goods plummeted below 1000 yesterday, down 92pc since peaking in June. The daily rental rates for Capesize big ships have dropped $234,000 to $7,340 in weeks, leaving operators stuck with heavy losses on long leases. Empty ships are now crowding Singapore and other global ports.
  • "It is extremely serious, " said Jeremy Penn, president of the Baltic Exchange. "Freight rates have never fallen this steeply before. It is telling us that world trade in raw materials has slowed dramatically. Shippers are having genuine difficulty obtaining letters of credit from banks," he said.
  • It is also beginning to cause strains in Greece, where the yield spread between Greek 10-year bonds and German Bunds rocketed to a post-EMU record of 123 basis points yesterday. Ominously for Greece, this is the first time its debt has broken its tight linkage with Italian bonds – which traded at spreads of 100 yesterday. The markets are now clearly singling out the country as the most vulnerable of the EMU members. "Shipping has overtaken tourism to become the country's biggest industry. They get their finance from other countries, so I think there are going to be a lot of worried bankers in London," he said.
  • Shipping specialists say the Royal Bank of Scotland and HSBC provide the lion's share of loans for both the bulk goods and tanker fleets, exposing these two banks to further potential losses.
  • Greek shipping families control a third of the global freight market for bulk goods, with operations split between London and Pireaus.
  • Michael Klawitter, a credit strategist at Dresdner Kleinwort, said the market flight from Greek bonds marked a dangerous moment for the euro. "There has been a massive widening of spreads. We are no longer having a theoretical discussion about the viability of monetary union. People are really concerned for the first time," he said. Greece has a current account deficit of 15pc of GDP, the highest in the eurozone. Investors were willing to turn a blind eye to this during the credit boom, but they have now become wary of any country with a deficit in double digits.

Bookkeeping: Weekly Changes to Fund Positions Year 2, Week 13

Year 2, Week 13 Major Position Changes

Fund positions of 1.0% or greater can be found each week in the right margin of the blog, under the label cloud and recent comments areas; I highlight weekly the larger position changes.

Being a long only fund, via Marketocracy rules, the only hedges to the downside I have are cash or buying short ETFs. I cannot short individual equities.

To see historic weekly fund changes click here OR the label at the bottom of this entry entitled 'fund positions'.

Cash (1 position [SHV] + cash): 54.8% (vs 28.1% last week)
30 long bias: 33.5% (vs 53.1% last week)
7 short bias: 11.7% (vs 18.8% last week)

38 positions (vs 39 last week)
Additions: PIMCO Strategic Global Government Fund (RCS)
Removals: Thoratec (THOR), ShengdaTech (SDTH)

Top 10 positions = 26.4% of fund (vs 45.6% last week)
22 of the 38 positions are at least 1% of the fund's overall holdings (58%)

Major changes and weekly thoughts
I spent most of the week selling; I'm neither bear nor bull here in the near term. With the hope that either fundamentals or technicals begin to work again we'll use technicals first with hope their signals work first. On the S&P 500 we've been below the 20 day moving average essentially for 2 months except 2 days in late September. We are now back there (S&P 970), despite moving through it intraday on Friday. So I'll call this the top of range 1; the low end being the lows we hit multiple times - literally 4 times in the past month including 3 of the past 6 sessions on an intraday basis; S&P 850. On range 1, we are at the very top but only in a very oversold rally should we not even be able to break the 20 day moving average... that's a serious bear. The next range higher, "range 2" would be the space between the 20 day and 50 day moving averages. In this are S&P 970 is not the ceiling but the floor if you will. If we can make a move above that than a move onward and upward to reach the 50 day moving average - currently at 1070s range and falling by the day - would be a logical conclusion. We have not meaningfully over the 50 day moving average since the first few days of June....

This is a lot of technical mumbo jumbo for some, but frankly in a market where industry veterans have been robbed of every tool that has worked for years from the fundamental point of view (and the past few weeks the technical side as well) you can bet every super computer - and human trader- is looking at these same spots. As I said Friday this is an abnormal market where it seems when the S&P 500 is up, every stock is ok to jump into and when the S&P 500 (or whatever index) is down - everyone flees every piece of merchandise. This is not healthy action and needs to stop for us to be intermediate term believers. Stocks within a sector need to separate themselves and the good trade different fromt he bad. The same goes for sectors themselves - they need to act coherently and not in one monolith. I call this "student body left" or "student body right" - that has been the action for a long while now and until it changes it's hard to get behind the market. That does not mean we cannot rally - it just means it's going to be an oversold rally that is based on nothing but reversion to mean. For the uber bulls, and it is still far too early to talk about it but there is a "range 3" between the 50 and 200 day moving averages - and the gap is huge due to the enormous selloff we have had.

On the economic front I expect many reports to degrade meaningfully now as we enter the meat of the recession - but it shouldn't come as quite as a surprise as the last batches have. Not a surprise to us, but apparently many on the Street. So as always we have to answer how much of this is already priced into the market? You never know except with a rearview mirror after the fact. This Friday's labor report should provide a good proxy. The other new question of this age is how much more do the hedge funds have to liquidate. My thesis a few months ago was we'd have hot and heavy selling through Dec 31st as many funds simply "quit" because it is going to take 1-2 years just to break even with this year's performance and it's not worth it for them with their performance fee structure; but as with everything in this day and age - things happen in lightning speed and what I assumed would take 4-5 months seems to have happened (is happening) in the span of weeks or a month or two.
We still have the back third of earnings season (smaller to medium companies) mostly with us, but in "student body left" trading, individual companies have not mattered too much - that said, when I see misses nowadays I see individual stocks blowing up to the tune of 20-35% drops even after already selling off by massive amounts in the bear. Which means holding individual stocks still carries a great deal of risk. Hence as our portfolio shows we're focusing more on ETFs and we sold a lot of stock into this rally as we edged to the top of "range 1" - if we can hold here and build into "range 2" over the coming weeks, we'll happily buy back some exposure higher. We're seeing some fantastic fundamental performance by such varied companies as Sohu.com (SOHU) and Flowserve (FLS), but we need to see gains hold and not completely sell off within a week or two. To make any stand we need to get back people who hold stock for more than 1 day or 3 days at most.

As for sentiment I'm torn here - I'm seeing a lot of permabears turn bullish and a lot of people drinking Kool Aid when a week ago we were limit lock down on the S&P 500 and everyone was tossing stock to the market gods. But on the other hand I'm reading a lot of people expecting that we've had our bounce and its time to falter. So we really have no advantage to sentiment here - and hence why I'm Switzerland right now (neutral). I can make a case either way - personally in most markets I don't care which way the market goes as long as individual companies are rewarded on their own merit, but with almost every stock trading in tune with the market; the market has become everything.

So we'll see if this was indeed the "Volkswagen bottom" or the market is just teasing us.

The larger weekly changes (chronologically) to the fund below:
  1. Monday, we closed Thoratech (THOR) on what seemed to be incredibly dire news Friday after hours. The stock was down as much as 50% after hours Friday but only was down about 12% when we sold Monday AM. Later in the week the company reported stellar earnings, which is why we bought it in the first place, and actually ended the week exactly where it was a week ago Friday. Based on "the world is ending" as it appeared 7 days ago - I'd consider that a major victory. I still like the idea here, but there is too much uncertainty for me right now - especially in a market teeming with cheap stocks that have no overhang. But one day - if the current issue is deemed to be manageable - it might be seen as a great buying opportunity. For now, we'll stay on the sidelines.
  2. To replace that long exposure we added to our Luminex (LMNX) position which was down 50% in 30 days - down to the mid $14s - the next day it fell to the mid $12s! By Wednesday though it was back to the mid $17s. All that in 48 hours - welcome to the biggest casino on Earth where fundamentals mean nothing. We took profits in the $17s and later in the week as it approached $19. You see similar trading in many names - all dice throws.
  3. Wednesday in "student body right" the commodities were making a huge move up; we have 3 positions remaining in this space (2 fertilizer, 1 coal) and with this market not discerning among specific subsectors consider this "1 position" - it entered the week at 12%; we took it down to 6% Wednesday and then liquidated more as the week went on. Many names still remain dirt cheap and oversold so could conceivably rally further but there has been a good move thus far and not taking advantage in this market where gains are erased in hours would be foolish.
  4. We also closed ShengdaTech (SDTH) even if it's very cheap. So many small cap Chinese names are treated now as if China is entering a black hole - the reality is even when the market rallies it favors liquid large cap names that institutions can get in - and more importantly - get out of - quickly. If animal spirits return for a sustained period of time - many of these names could go up 50-100% and still be "cheap". That could happen tomorrow, in 2 weeks, in 2 months, or 2 years. We don't know - but in the "current" market - this is not the favored merchandise.
  5. Thursday, we took another round of profits - quite a bit of solar was let go as these stocks have high capital requirements and are trading on sentiment more than anything. If sentiment returns to "companies can get credit" these stocks should soar - maybe Obama will help. First Solar (FSLR) had a good earnings report and the rest of the Chinese solars report in the coming 2-3 weeks.
  6. We took profits on AeroVironment (AVAV) after the stock popped up on a Cramer mention earlier in the week. Would like to get back into this one at a lower price if it pulls back - one of the very few charts looking healthy.
  7. Friday, we took profits in Sequenom (SQNM) after a strong push post earnings. Not sure why exactly the stock took off since the earnings report was modest but the stock has been very oversold.
  8. We began a new position in PIMCO Strategic Global Government Fund (RCS) as there appears an opportunity to derive a nice yield while the closed end fund is at the low end of its 52 week range.
  9. We added to two contract research organizations, Kendle International (KNDL) and Life Sciences Research (LSR) as this group has been extremely hard hit in the past 7-10 days and has lagged the recovery of other stocks.

The above do not include the majority of my trades in my Ultrashorts which I am trading quite often as the market ebbs and flows

Friday, October 31, 2008

Bookkeeping: 'Rising Tide' Performance Year 2, Week 13


Year 2, Week 13 performance of the mutual fund

: Another volatile week in a series of incredible volatile weeks... 2 months in fact. With a big rally this week we avoided living through "the worst" month in stock market history and instead have been upgraded to "one of the worst" months in history. At this point, and this is just a gut call, the market feels empty - it can be moved so quickly and direction changed on a whim. This would make sense from the perspective that the marginal trader in this market the past half decade especially has had the margin call of a lifetime, and those that remain around have moved to high cash positions. So this allows the hedgies that still play to have outsized weight on the market. Even today which now "feels" like a calm day would of been considered head spinning 6 months ago. From top to bottom we only had a 4% range (and I use the word "only" in relation to what has been going on to the past few months), but we rallied up 4% then at 3 PM down 1.5%, and then spun and made an about face with 10 minutes to go for one of our traditional "multi % move in 10 minutes or less" that have characterized the last hour of trading for a while now. Something is going on in the background, but I don't know what it is and the SEC sure won't bother to figure it out.

What I see in the market is continued "student body left" and "student body" right trading. Everyone is keying off the S&Ps (or their index of choice) and if it's going in the right direction every stock is "good" and if it's going in the wrong direction ... well every stock is "bad". This is still not a healthy thing. We need to see separation among stocks and sectors. Further, the VIX is still above 60 which any other time in history would be "historic" and "emergency panic" - today it's a "calm day". Much like we'd complain about $2.40 gas two years ago, now we say "whew! that's nothing versus where we have been lately" - this is the same parallel I see in the market now. It's still not really too healthy.

The leadership is also poor - by leadership I mean there is none. Today for example it was mostly retailers. Earlier in the week commodities. Neither are leadership - they are completely broken sectors that were oversold by historic levels, rebounding to a more normal reversion from the mean. The only sector I see working consistently is airlines - which is nothing more than an anti-oil trade. I'd also like to ask out loud how come with all the debt airlines have NO ONE is buying their credit default swaps and crying in the media that they won't be able to roll over their paper and hence the stocks should lost 90% of their value within 3 sessions. I mean they are even doing that to casinos nowadays but somehow the airlines are bullet proof? Some of the most debt laden companies with the best performance - only in this market of nonsense. But the larger point is where will the leadership come from - you can't go to global growth names because of the global slowdown and you can't really believe in US centric names unless you're going to pull out the same old tired thesis the bulls pulled out this summer about how $1 less per gallon will save the consumer. So after this initial move from a deeply oversold condition I'll be interested to see where the bulls plant the flag in terms of the "new leadership" group.

I pointed out last week's intraday highs on the S&P (985) as the point I'd like to see the market pass to become more bullish - we made an attempt today and lo and behold 983 was hit, before a rejection ensued. But the action seems a bit more positive - but again we're comparing it to what was shaping up to be the worst month in history. Next week we have the Tuesday US election and more important the monthly labor report. Obviously if you are paying attention you see large job losses announced left and right, 3000 here, 5000 there, 7000 over there. This will be filtering into the claims over the next 1-6 months and we're going to see some quite scary numbers. How quickly they filter through is anyone's question but it's not the news but the reaction to the news that matters. At some point you get numb to the bad news just like we did earlier this year when financials rallied as no amount of write off mattered anymore - we had become numb to it. So when you start seeing good stock reactions to bad news - you have a rally you can believe in. But still within a bear market. On the "positive side" ideas we've been presenting in the blog for the past 16 months are now spoken about EVERYWHERE - so at some point it gets discounted. It is when these thoughts are only whispered on some "doomsday blogs" (i.e. us) that we should of been more worried - when everyone else caught the drift of the severity of the situation the reaction even surprised us in it's severity (along with the Margin Call of the Century). So now everyone knows things are rotten aside from a few remaining pundits they trot out on CNBC - now it's a matter of degree, severity, and duration. I don't know the answers myself - we'll have to see how the 21,181 solutions presented by government work and if banks stop hoarding. If so, we'll just have a lengthy recession in which we'll exit with a much tighter credit world. If not, we have a lot worse backdrop. I think we'll know within 3-4 months which fork in the road we'll take.

For the fund I spent most of the week selling into the strong rally. We made money this week which I guess cannot be complained about but we lagged due our performance Tuesday. We almost always lag the huge up days in the market since we are always carrying cash and some short exposure but we had quite a bit on the short side Tuesday and hence all our long gains were extinguised by the short side (i.e. we were "perfectly" hedged) and we made nothing on a day the market was up 10%+. I can only imagine the calls coming into the office by enraged shareholders Tuesday night... every other day of the week we either kept pace with the market or outperformed despite holding very large amounts of cash and not being very exposed to the market. But Tuesday led to under performance versus the indexes.

The S&P 500 gained 10.5% and the Russell 1000 gained 11.0% on the back of Tuesday's monster rally. Rising Tide Growth gained 4.7%. We actually had a very quiet week - Monday while the market was down 3%+ we were down 0.3%, Tuesday while the market was up 10%+ we were up 0.3% and so on and so forth. Made some up of Tuesday's lack of participation in the back half of the week, but we had almost no volatility this week while the market acted like a 3 year old on a sugar high. So we're back to trailing the market in our year 2 after being ahead for a short while. We've trailed the market mightily the past 2 weeks as volatility whips us around.

*** Year 1 Results here: +10.1% vs -14.0% S&P (+24.1%)

Year 2 Metrics

Price of Rising Tide Growth: $7.902
Year 2 Performance to date (vs Aug 1, 2008): -28.24%

Comparable S&P 500: 968.8 (-23.1%)
Comparable Russell 1000: 523.3 (-24.2%)

Fund return vs S&P 500: -5.1%
Fund return vs Russell 1000: -4.1%

Last week's results here.

Since the market cap of the median stock in the Rising Tide Growth fund (median $7.1 Billion as of April 08) is significantly below the SP500 index (median $13.1 Billion as of September 07) but higher than the median market cap in the Russell 1000 (median market cap $5.8 Billion as of September 07), I am measuring the fund against both indexes. Click here to see all fund's holdings as of July 2008.

Basis for indexes for year 2 is closing price August 1st, 2008.
SP500 : 1,260.3
Russell 1000 : 690.3

Please click here: fund performance for previous updates

Bookkeeping: Adding to Kendle International (KNDL) Ahead of Earnings

For those who are newer readers, my general ethos is avoid stocks around earnings - while many get a kick out of the gambling associated with piling into stocks ahead of earnings hoping for the huge win - I find it a very risky game that has more bad outcomes than good. But the big moves in the small % of situations keep luring the gamblers... err investors... back to this (ahem) strategy.

Kendle International (KNDL) reports on the 4th and I am going against my normal rules to add quite a bit of exposure ahead of earnings. We've outlined this week how the contract research organizations have been a total disaster of late [Oct 28: Contract Research Organizations Taken to Woodshed] as there are now worries about both the US dollar and pharma companies trying to save money any way they can - including less outsourcing of research. Since costs are generally higher when they do the work in house that seems backwards but no one said companies were rational. They might also just cut back on drug R&D altogether if credit conditions continue to be poor and funding remains difficult. Those are viable issues but the stocks have now priced in a ton of bad news. Parexel Interational (PRXL) who had the most blatant warning, along with some company specific issues has been cut in half, in the past 7-8 sessions. Kendle International meanwhile, simply by being in the same industry, also has been cut in half. I don't necessarily expect great things from Kendle as there do appear to be headwinds in the industry, but it is now valued under 10x 2008's estimates, which is cheaper than the company which had the major warning in the sector, PRXL.

Under a portfolio management view, with the understanding I've been selling long exposure all week, I am willing to take a flier on this one and do some buying on the long side. #1 the stock has been trashed as if it had the earnings warning, even though it has not and #2 the stock has not participated in the rally - so if this rally has legs (which I have doubts until we break over S&P 985) stocks that have yet to rally should pick up steam. This could also be viewed as a transfer of long exposure from stocks at resistance to those nowhere near it - many of the stocks I sold off now have run up to important resistance levels and face some work to do to continue up. Kendle, at $18, is a full $11 away from any serious resistance if it should provide some reassurance on the call.

I cut some Kendle earlier this week at higher levels during the obliteration of the sector but am now taking it from a 0.9% stake to 2.9% stake. I am also adding to Life Sciences Research (LSR) - same boat, same sector, same chart, same valuation in the lower $16s and taking it up to a 1.4% stake from 0.4%. From $16, the 20 day moving average is way up at $23.

If the market "melts up", I am poorly positioned as are many so we'll all be scrambling to add long exposure from here. Funny - a week ago to the day the S&P opened limit down in premarket and no one wanted stocks - now my normal sources of info on the web are all rampant bulls. Human emotions - they are a funny thing. Any real move should have sustained legs so while not fun to miss the beginning, we can catch up later if there is any duration to it. A market let by consumer discretionary is simply not one I believe in - these are simply oversold stocks rebounding from stock prices that signaled the US was shutting down its doors for half a decade. But the action still looks suspicious to me with these huge 2-3% moves in 10 minute spurts. But we're only 8 S&P points away from my 985 point and in this market that can be done in 90 seconds.

Long Kendle International, Life Sciences Research in fund; no personal position

Bookkeeping: New Position in PIMCO Strategic Global Government Fund (RCS)

Continuining my path to full fledged fuddy duddy, I've been looking at bonds for return for the first time in my life. In normal bear markets bonds have held up reasonably well but in "this mess" bonds have been demolished along with stocks. All asset classes short of US Treasuries have been decimated. This led me to thinking about buying a high quality US Corporate bond ETF/closed end fund. You can get a lot more yield with "junk bonds" but at this stage of the economic cycle, with what I believe will be an ugly recession still ahead I don't want to take that risk now since I can see quite a few companies going out of business in the next 18-24 months. Perhaps a year from now a junk bond would make more sense as the reality of the coming situation is further priced into the market.

Instead I'd rather be in something like iShares Investment Grade Bond (LQD) which is yielding in the mid 5% range, while holding a lot of higher quality debt. Typical holdings include Johnson & Johnson (JNJ), Walmart (WMT), Berkshire (BKRa), and IBM (IBM) debt - safest of the safest. Looking over the past half decade this normally always traded in a 0 to 1% premium to NAV but spiked to 2% this year. However in the past month its cratered (on a relative basis) from a +1 premium to -2% discount to NAV. That is a very rare occurance for this sort of holding - and just reverting to the mean on that gap would be a 2-3% gain. So in theory you could get mid 5% yield plus a 2-3% appreciation in the underlying instrument as we move from a rare discount to a more normal small premium to NAV. So 7.5% to 8.5% potential for instruments that should be "relatively" risk free - the biggest and best US companies debt.

LQD is high on my list and I may yet buy it, but as I was researching the corporate bond alternatives I came upon an interesting fund that I am going to choose today instead - it is PIMCO Strategy Global Government Fund (RCS) - website here.

Primary objective is to seek to generate, over time, a level of income higher than that generated by high-quality, intermediate-term U.S. debt securities.
  • Invests primarily in a diversified portfolio of U.S. and foreign government securities.
  • Seeks to generate greater income than high-quality intermediate-term U.S. debt securities, while maintaining a comparably stable net asset value.
  • Also seeks to maintain volatility in the net asset value of the shares comparable to that of high-quality, intermediate-term U.S. debt securities.
  • Leverages PIMCO's core analytical and risk-management capabilities.
It currently yields in the mid 8%s and trades in the lower third of its historical range of premium to NAV - generally its been trading at a 5 to 20% premium the past 5 years, and is currently around 10%. Most importantly is what it owns - it is focused on Fannie Mae, Freddie Mac, and Ginnie Mae debt. What is Ginnie Mae? It's basically what Fannie and Freddie have now become - mortgage backed debt explicitly guaranteed by the US government. So the nature of this instrument's holdings has changed since the take over of Freddie/Fannie - in the past the Ginnie Mae debt was explicitly guaranteed while the Freddie/Fannie was "wink wink" guaranteed. Now it is all guaranteed - unless your thesis is the US government will default on it's debt. I don't see that happening for about 15-20 years out. And most others never see that happening. So in theory just about all the holdings are government backed and (cough) "risk free". With the Federal Reserve killing all US savers with their interest rate cutting, this yield is bordering on 3x as much as many CDs.

On a 1 year basis RCS has traded in a $9.25 to $11.75 range other than in the panic lows earlier this month where it traded in the $7s! $8s for 2 days. Outside of that, $8.75 has been the panic floor. So we're buying it today in the $9.20s and $9.30s. So obviously if it just sits here we get an 8.5% yield which in this market is like 50% in a bull market. And if it makes a move into the $10s or even better $11s - we throw some nice capital appreciation on top of it. The last positive is this is a PIMCO based which is the most stable (and largest) bond shop in America so we should not run some risk of some unknown event that other money market or bond funds might run into (have to think of every contingency nowadays)

I'm working on about a 5.5% position in that range that we'll be buying and hopefully be done by end of the day. It's relatively low volume and by Marketocracy.com rules I only get 10% of every real world trade counted towards our purchase i.e. 1000 shares in the real world translate to 100 shares in the account. RCS trades about 115K shares a day, and already we are through 35K so we might not complete this today. Since this whole bond business is new to me I'll consider adding more once I watch this for a few weeks/months and see how it behaves in real time. It won't be something we trade very often at all, but a place to stash long exposure in a market that has no rhyme or reason and where stocks act like pinballs.

Any reader who happens to own these type of instruments on a normal basis, feel free to comment or email and give me your thoughts and pros/cons you see to my analysis.

From a contrarion point of view I want to bet against myself and go 100% long because when someone like me is buying bonds it must mean the bottom is in ;) Next.... as you watch me turn to Certificates of Deposit as a risk aversion tactic it's time to 2nd mortgage your house (errr, ummm.... ) and go on margin on the long side.

Long PIMCO Strategic Global Government Fund in fund; no personal position

Bookkeeping: Cutting some Sequenom (SQNM)

Sequenom (SQNM) is jumping 10% today and is up from $14 to $18+ in just a few sessions so I'm going to take this opportunity to cut back hard on the position; we are selling in the $18.10s down from a 1.9% to 0.5% stake. The 50 day moving average is in the lower $19s and if technical analysis means anything in this era, we'll be an avid buyer above that level if the stock shows strength.

Until the market stops acting like a casino we are going to continue to retrench. Just as Wednesday the market lost 3%+ in a 10 minute span late in the day, yesterday we had a 2%+ rally in a span of 10 minutes on the S&P in the last half hour. Something just appears fishy for the market to be moving around this rapidly in 5-10 minute spans, especially late in the day.

I'll be a buyer on strong pullbacks, but unless the overall market breaks north of S&P 985 as I wrote yesterday, I'm not a believer in a sustained move - but even "choppy sideways action" would be a huge improvement over what we've sustained the past 2 months. Targeting which stocks to buy is difficult as the biggest movers just seem to be reverting to a mean. Chasing them up after large moves has proven to be folly so until that pattern breaks we'll be sellers, not buyers after these big moves. If the pattern changes, we'll change along - but not until....

Long Sequenom in fund; no personal position

Bloomberg: Credit Tsunami Swamps Trade

A very interesting story on Bloomberg which leads to the question I posed yesterday in the coal piece - how much of the "global slowdown" is true supply/demand characteristics and how much is outside financial influences - in this case the inability to access credit. We'll never know in aggregate but a lot of interesting anecdotal evidence is emerging that the credit situation is a major issue. Then once you have all that answered the next question is when does credit get back to a "new normal" and what will new normal look like. When you have those answers, please email me ;)
  • Richard Burnett's lumber company had started loading wood onto ships heading for China. More was en route to the docks. It was all part of an order that would fill 100 40-foot cargo containers. Then Burnett got a call from his buyer at Shanghai VIVA Wood Products Co. The deal was dead. He told Burnett, president of Cross Creek Sales LLC in Augusta, Georgia, he couldn't get a letter of credit to guarantee payment for at least six months. ``It was like a spigot got cut off,'' Burnett said, recounting the transaction that fell apart in July. The inability of buyers in China and Vietnam to get letters of credit has cost his company as much as $4 million this year, a third of projected revenue, forcing him to lay off 15 of 35 employees, he said.
  • Suppliers of oil, coal, grains and consumer products from Chicago to Mumbai are losing sales as the credit crisis spreads beyond financial institutions, and banks refuse financing or increase the fees for buyers. Coupled with declining demand, the credit squeeze is threatening international trade, one of the lone bright spots in the global economy.
  • Global trade volumes may sink next year, their first decrease since 1982, according to Andrew Burns, a lead economist at the World Bank. While there is still uncertainty over future prospects, trade may contract by as much as 2 percent, after annual increases of 5 percent to 10 percent over the past decade.
  • ``We only see this kind of shock when we have outbreaks of war, or maybe the oil shocks of the 1970s,'' said Kjetil Sjuve, a commodities shipbroker at Lorentzen & Stemoco AS in Oslo. ``This lack of credit was a shock to the entire economy. We were hit second after the banks.''
  • Of the $13.6 trillion of goods traded worldwide, 90 percent rely on letters of credit or related forms of financing and guarantees such as trade credit insurance, according to the Geneva-based World Trade Organization. Letters of credit are centuries-old instruments that allow far-flung partners to complete large transactions. An importing company gets its bank to issue the letter, guaranteeing payment for a delivery. That bank provides the letter to the exporter's bank, which then guarantees payment to the exporting company. The system breaks down when banks don't trust one another and are unwilling to accept a letter of credit as proof that payment is coming.
  • From 2000 through last year, the use of letters of credit declined to about 10 percent of global trade transactions, the IFC's Stevenson said. Over the past six months, they began ``roaring back into fashion'' as sellers sought to guarantee payments from buyers they no longer trusted, he said. At the same time, liquidity problems caused banks to increase charges.
  • The cost of a letter of credit has tripled for buyers in China and Turkey and doubled for Pakistan, Argentina and Bangladesh, said Uwe Noll, director of country risk sales at Deutsche Bank AG. Banks are now charging 1.5 percent of the value of the transaction for credit guarantees for some Chinese transactions, bankers say.
  • ``The whole global trade production line relies on letters of credit,'' Matt Robinson, an analyst at Moody's Economy.com wrote in an Oct. 23 report. ``No letters of credit, no transactions -- and no transactions mean no international trade.''
  • James Morrison, president of the Small Business Exporters Association in Washington, polled 1,000 of his members this month on the impact tight credit is having on their ability to trade. By a margin of six to one, companies that had tried to get export financing recently said they faced ``unusual difficulties.''
  • The same is true in Brazil. An Oct. 23 report from the country's Confederacao Nacional das Industrias, which represents 27 industry groups and 7,000 trade associations, found that Brazilian companies of all size are losing access to credit.
Well it appears our Federal Reserve has another thing to backstop - the worldwide letter of credit operations. I wonder what the price tag is - doesn't matter though. Our pockets are limitless and printing presses never wear out.

We'll have to see if this situation improves in the coming months now that the world's central banks have come to the rescue of the banks. I'm surprised the railroads which ship items to US ports did not talk about this or perhaps I just missed it.

Wall Street Journal: Universities Begin to Feel Crunch

All these stories we post continue a mosaic of higher costs of living for Americans in the long run as median wages falter. In the "richest country on Earth" many kids have been forced to borrow $20,$30,$40K to get higher education - creating a ball and chain around their lives for the first decade post graduation. Or robbing their parents the ability to save for retirement. The house ATM hid this situation for half a decade but now we're seeing reality. Looks like costs are set to even go higher... remember our thesis that state budgets are going to be a complete disaster in 2009 - which means sharp reductions in what states can give to their state universities.

At some point the discounted cash flow model is going to show that it is better to begin work at 18 - at a lower wage - and skip the 4 years of wasted earnings potential plus the massive debt many are now being forced to pay off from their higher education. In fact, I would not be surprised if we've already passed that point for many careers outside law, medicine, and the like. Remember the chart we outlined in September at how far ahead of inflation college tuition is rising. A breaking point must be reached at some point as people cannot borrow against their homes to help their kids go to college.
  • The financial and economic tsunami that has ripped through Wall Street and the housing market is beginning to wash across the college green. Higher education hasn't yet seen anything to compare with foreclosures and bank nationalizations in the private sector. But seized-up credit markets, shrinking endowment funds and a reduction in state subsidies are punishing universities from California to Vermont.
  • A campus construction boom is slowing, administrations are cutting jobs and faculty may be forced to pay more into their pension funds. The demise of a $9.3 billion investment fund used by 900 colleges has some schools scrambling to pay their bills.
  • College construction soared to $15 billion in 2006 from $10 billion in 2001 (50% increase in 5 years? obnoxious)
  • It all brings a gloomy pall to what has been, until recently, a booming industry. Higher education has grown rapidly in the last half-century into a formidable slice of the economy. U.S. colleges and universities spend $334 billion annually, employ 3.4 million people and and enroll 17.5 million students. (aka it's now a "big business" but without the cost cutting of most enterprises)
  • The boom was powered by a growing stream of donations, strong returns on endowments, rising enrollments and tuition prices that climbed well above the rate of inflation -- paid, more and more, by families who borrowed heavily to meet the bills.
  • he cratering stock market has already hit endowments. Falling markets typically take a toll on gifts, many of which are made, for tax reasons, in the form of appreciated stocks and bonds. Analysts and schools are predicting even bigger tuition increases than those seen so far. But this time, families may be in no position to meet the higher bills. Falling house prices have sapped their ability to use home-equity loans for tuition payments, and the credit crunch has forced many lenders to stop making student loans. (bingo)
  • "This is the worst environment for colleges I can remember," says Mark Ruloff, a consultant at Watson Wyatt in Arlington, Va., who advises college endowments. With their ability to raise capital curtailed by the crisis, schools may be forced to sell their most liquid endowment assets at a time when the markets are not offering much, he predicts.
  • Molly Corbett Broad, president of the American Council on Education, which represents 1,600 colleges and universities, says public schools face the greatest challenge in a slumping economy because they get as much as three-quarters of their revenue from state taxpayers.
  • She says students could face double-digit tuition increases next year, up from the typical 4% to 6% level in recent years. Some university presidents privately confided to her that their institutions, which she declined to name, are even considering midyear tuition hikes. (how much blood can you squeeze from a rock?)
  • Ms. Broad adds that small private colleges without hefty endowments may have to consider merging with bigger rivals.
Some examples of the current situation, and again - we haven't seen anything yet...
  • University of Massachusetts system this week said it would have to cut its budget by about $25 million, or 5%. The flagship Amherst campus froze hiring in all but the most critical positions.
  • Boston University's president sent faculty a letter late last month announcing that the school is imposing a freeze on new hires and new construction projects.
  • The state of Colorado has frozen hiring and state construction projects, including about $50 million worth at public universities
  • The Tennessee Board of Regents, which oversees the University of Memphis, five other universities and 13 community colleges, has been forced to cut $58 million since July. Bob Adams, vice chancellor for business and finance, says the system, with 190,000 students, may have to increase tuition "fairly significantly" next year. Including tuition, room and board and other fees, students typically pay $12,500 annually.
  • The University of Memphis recently announced a voluntary employee buyout program. Mr. Adams says schools are also delaying equipment purchases, such as laboratory equipment, and library acquisitions, including books and subscriptions. He says he suspects that classes will get larger because of rising enrollments and shrinking staffs.
  • The University of California, Berkeley, faces $28 million in cuts or unavoidable cost increases for the academic year that began in July. He says that rising health care costs will result in an 11% increase in the cost of providing medical and dental benefits to staff starting in 2009.
Every time I read these type of stories I remember the CNBC pundits in summer 2007 saying "what's the big deal even if housing slumps (not that it will!); it is only 4.5% of GDP" What they forget is housing is the base of so much tax revenue in this country... the dominoes will fall one after the other through the system. And universities are actually going to have to act like private enterprises...

Thursday, October 30, 2008

Sequenom (SQNM) "Misses" But We Really Don't Care

Near term results for Sequenom (SQNM) are really a moot point as we're looking to mid 2009 forward on this story; the main issue in this new and (not so) improved environment is making sure young companies have cash to get them to the point where they turn cash flow positive. The New York Times actually had an article on the struggles young biotech companies are having in this new world.
  • So many biotechnology companies talk about “extending the runway” these days, you might think they had entered the airline business. But for them, runway refers to the time before a company runs out of money. And with financial markets in turmoil, the runways are looking dangerously short for many small biotechnology companies.
Honestly any revenue, or margins or financial issues at this point outside of cash are meaningless in my assessment - but for historical context we'll post the results.
  • Sequenom reported total revenues for the third quarter of 2008 of $11.6 million, an increase of 18%, compared with total revenues of $9.8 million for the third quarter of 2007.
  • Gross profit margins improved in the quarter to 60.9% from 54.6% in the same quarter last year.
  • Operating expenses rose to $17.8 million from $11.2 million in the third quarter last year due to additional expenses associated with the research and commercial activities for the Companys molecular diagnostic programs and approximately $1 million in fees associated with new technology and intellectual property licensed during the third quarter.
  • The net loss for the third quarter of 2008 was $10.4 million, or $0.18 per share, compared with the net loss for the third quarter of 2007 of $5.5 million, or $0.14 per share.
  • We are pleased with our results for the quarter, remain cautiously optimistic for the fourth quarter, and are reaffirming our full year 2008 revenue guidance of $50.0 million, said Dr. Stylli. We expect the Genomic Analysis business segment will reach cash flow break-even during 2009 with current growth rates and operational leverage. We believe we have sufficient capital to commercialize our noninvasive prenatal tests and turn profitable on a consolidated basis in 2010 or 2011 without further equity financing requirements.” (that's the only sentence that matters in the current report - debt is negligble)

  • Net loss is expected to be approximately $39 million, up from prior guidance of $36 million, due to costs expected in connection with the acquisition of the CLIA-certified laboratory (CMM) and other licensing activities.
  • Cash burn is expected to be approximately $36 million, compared with prior guidance of approximately $30 million, due to the expected completion of the acquisition of the CLIA-certified laboratory (CMM) and related capital expenditures required to prepare the laboratory for large volume commercialization, and intellectual property related expenses, among other expenses.
The company presents at 3 health care conferences in November, but this is really a "milestone" story at this point; each step to the holy grail should add to valuation. This should be one of those home run or strike out type of stocks. Obviously we're here for the home run potential but in this market where "risky, growthy" stocks are eschewed, and "investing" is laughed at while day traders play in the sandbox - it might struggle for a while.

[Sep 23: Sequenom - All Systems Go on Down Syndrome's Test]
[Aug 13: Beginning Stake in Sequenom]

Long Sequenom in fund; no personal position

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