CLWR - New Twists in the Story

As many of InvestingDecoded readers already know, I like to continue follow the stock that I mention on this blog so I can keep readers apprised of happenings on those companies. One of the stocks that I had mentioned a while back is Clearwire, the wireless broadband company that sells internet access through its 'Clear' brand name. This company in many ways is a pioneer in the internet space. Its service is the first mass-marketed wireless internet service that provides users with 4G access by utilizing the Sprint broadband network. However, given the recent developments in the company, this pioneering spirit may now be its downfall.

The Background

Before we get to the juicy developments, let's talk a little about background. The most interesting aspect of CLWR is its ownership structure. The company was formed by a consortium of some of the biggest technology names including a 54% ownership stake from Sprint corporation. Other stakeholders include Comcast and Intel. Now comes the interesting part. As I've learned over the last couple of months, the primary reason that Sprint even got involved in creating the company was to create a technologically advanced platform from which to build its own 4G offering. But the way the ownership structure was created, Sprint did not have a direct say on CLWR's operations, and CLWR went ahead and created its own wireless broadband offering, essentially competing directly with Sprint.

The DL

Now this has apparently been somewhat of a flash point between the two companies for a while now. However, it has recently come to a head as CLWR has been hitting cash availability issues to fund its ongoing operations along with its ambitious expansion plans. As of 9/30, the company had $1.38 billion in cash and equivalents. That's down over $2B from the same time last year. To put this in perspective, operating losses for the quarter ending 9/30 were $540M, meaning the company can potentially run out of cash by end of next year.

In the past, Sprint has come to the rescue and injected fresh capital into the firm. However, it seems that its reluctance to do so now is an indication that the firm is finally trying to wrestle some control of the company. The latest rumor is Sprint my try to kill the Clear brand all together so it isn't a competitor to Sprint's own business. Instead, CLWR would become the wholesale technology provider to Sprint that Sprint originally hoped for.


Potential Impacts

This ordeal has already had a pretty drastic impact on CLWR with its stock down 30%+ in the last few months alone. The more important issue now is what the potential impacts are. Personally, I don't think that Sprint will completely kill off the CLWR name, nor will it allow CLWR to go under. The company does have an emerging brand name and strong infrastructure. Letting all that go would be foolish. Instead, I expect Sprint to arrange a new ownership structure for some bridge financing. The terms will likely be strict since Sprint itself isn't in too much of a position to help other companies since it has plenty of problems of its own.


Where Does the Stock Go From Here?

At least in the near term, I see a lot of the same volatility in the stock. However, I see limited downside potential since the company has already come down to a reasonable 7x EV/Sales multiple from a high 13x earlier this year. I see the stock trading flat overall, but there may be some trading opportunities available in Call options.

Longer term, I see some potential upside, but that really depends on how the funding crisis is resolved. Although I think it will be resolved, I can't say what the terms will be and if they will be good for shareholders.

CLWR is a good company that has a product that I feel has great long-term potential. If you want to get involved in the continued wireless revolution, CLWR would be a good way to do it. However, be ready to stomach some serious volatility and risks.

The Equity Exodus

A few days ago, I was reading an article regarding a shift that is occuring within the world of institutional investing. For those that don't know, institutional investors are entities such as pension funds, endowments, and trusts where large pools of money are invested with a stated goal (e.g. employee retirement contributions are invested to provide future retirement income in the case of pension funds).

Anyway, the article discussed how there's increasing evidence that institutional money was shifting away from equities and into fixed income markets. Up until the financial crisis, the opposite trend was occuring. Investors like institutions that generally bought more stable products were safer. However, because of the outsize returns that were being seen in the stock markets, and the growing obligations many of these institutions were facing, many increased their stock exposure in the chase of the proverbial carrot.

Well, as I'm sure you've realized already, those outsize returns disappeared in a huge hurry, and many institutional got burned just as severely as individuals. Now it looks like the money is shifting back the other way.

So What?

I think the shift away from stocks to safer alternatives is particularly interesting for several reasons. First, I think this will definitely have an impact on the markets. These institutions literally have trillions of dollars to manage, and moving just a tiny fraction won't go unnoticed. More specifically, I think that as this trend continues, stock markets will become more volatile and have at least some downward pressure. This is because institutions tend to be more longer term investors and don't trade in and out as quickly, so having that kind of money in the market provides stability to the investment. Stocks will lose this stability and it will likely move to bonds (although I should note, many institutions also invest in alternative assets and hedge funds which often have shorter duration investments).

Uncle Sam Likes This Too?

Another interesting point along these lines is how this impacts government spending. A lot has been said recently about the so-called 'bond bubble'. There has been huge demand for the relative safety of bonds, particularly treasuries, and many investors think bonds have become over-valued. Nonetheless, Uncle Sam loves this, because he is able to issue more and more bonds for fairly cheap prices (he only has to pay 2.56% on a 10 year bond right now!). Although values have gone up significantly, I think this shift from institutional investors may lend credence to the theory that bond prices have more room to go up, or at least are not going to come crashing down.

Too Late to the Party?

Now let's flip this around again. Yes the inflow of institutional money into the bond market would provide support for bond prices. However, there's been a huge runup in bond prices over the last couple of years. I do agree that they will provide stability to these institutions. However, I do question the timing of the move. If there is a significant recovery in the economy, these funds can easily get burned.


The apparent reallocation of institutional assets from equities is likely to have a sizable impact on the markets. Although it is not yet obvious, I think stock prices could be adversely affected with this trend and we will see more volatility in the equity markets.

Durable Goods Orders – Light at the End of the Tunnel?

Last Friday, the Commerce Dept. released its monthly analysis on one of the most watched indicators of economic health in the US – durable goods orders. Durable goods are items that are expected to last at least 3 years or more. They range from consumer goods like home appliances and computers to commercial items such as aircraft and turbines (these are known as capital goods).

Why Is This Report So Important?

The reasoning behind the importance of durable goods is fairly intuitive. These items tend to be higher in price than other more common goods (e.g. consumer staples) and, therefore, require a greater investment from buyers. Consequently, buyers are likely to buy these goods only if they have confidence in their ability to pay for them. Furthermore, especially in the case of consumer durable goods, many of these items are discretionary in nature (you generally buy a new dishwasher if you want one, not absolutely need one). So the orders for these goods provide key insights as to the confidence of consumers at both the individual and commercial level.

The Numbers

The overall number released on Friday indicated that orders fell 1.4% in August. However, when looking deeper into the numbers, you find that if you exclude transportation items (i.e. aircraft which are generally very volatile), the orders rose a more than expected 4.1%. This gave investors some confidence that consumers and companies were increasing their spending and provided them hope for an economic recovery.

The numbers break down as follows:

· Electronics: +3.8%

· Machinery: +3.9%

· Transportation: -10.3%

My Take

Overall, I think the number is pretty solid. I’m especially encouraged by the broad-based growth in all categories (I’m not too worried about transportation because of its volatility – last month it was up 11.6%). If these numbers can keep growing, it should soon be evident that there is demand in the economy and, hopefully, this will result an increase in employment as durable makers adapt to meet this demand.

However, there is one variable that I’m keeping a close eye on before declaring any sort of victory. The inventory levels at these durable goods companies needs to be watched closely. Last month, those levels rose .4% and were up .6% in July. Although these aren’t huge numbers, there is definitely an upward trend. If it turns out that the durable goods growth is more of an anomaly, this growth in inventory may become a big liability for the producers. Next month, I want to see if this inventory trend continues – if it does, I feel it will act as a leveraging mechanism for the companies.

I feel the economy still has a long way to go before it can fully recover. With housing still remaining weak and a lack of hiring, a strong durable goods number can easily turn out to be a blip in the overall picture. However, if these good numbers become the trend, then I think the affect will trickle down to employment and hiring and, in turn, promote some badly needed GDP growth.

What are your thoughts?

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.

Another Revisit - MICC

About this time last year, I spoke about Millicom International (MICC) - the Luxembourg based emerging market wireless company that I heavily recommended (Check out the review post here). Back then, I had upped my price target for the mid-70's to approximately $90/share over the long-term.

Now, I am of the philosophy that you have to continuously revisit your investments and assess if they are still a good fit for your portfolio. Companies change, circumstances change and the reasons you bought a stock can get out of whack in a real hurry. As a wise man still says - 'Don't Buy and Hold, Buy and Homework!'.

Since that post, MICC has indeed risen in price and is now trading at right around $90. With my previous price target acheived, I dug into the numbers to see if it is still worth holding.

Still A Strong Business

For those that don't remember, MICC's primary business is selling prepaid wireless services in third world countries. This includes countries with little or no wireline infrastructure, making wireless the primary means of communication. The company operates in 3 regions - Central America, South America, and Africa with Central America being the largest segment in terms of revenue.

Looking at the last year, it's evident that MICC's business has recovered well with the global recovery. EBITDA for the last 12 months (LTM) came in at a healthy $1.59 Billion - a solid 19.5% increase over 2008 (which itself was a record). More importantly, EBITDA margin has held at a steady 44% which is on the high end for the last 4 years.

Looking Forward

But having a solid business thus far isn't the only factor we need to consider here. All that information does is justify the increase in the stock price, but it doesn't give us much insights into what we have looking forward.

Looking at the company's annual report presentation, one of the most promising numbers I see is the Customer penetration, specifically in data usage. I look at the emerging markets to somewhat mirror the developed countries in data usage growth patterns (the theory worked for voice mobile phone usage). According to the presentation, MICC's current data penetration for Latin America is 5.2%. Assuming that the number is similar for the MICC's other regions, and the average penetration growth rate for the company is 47%, I think there's a good deal of room for revenue growth for MICC. Therefore, I expect data penetration to be a solid source of revenue growth for the company resulting in total 2011 EBITDA of around $1.95 Billion (slightly higher than analyst estimates which MICC has done a good job of meeting over the last few years). Assuming the current Market Cap/EBITDA multiple of approximately 6X, we come to a expected price of $107 - an almost 20% jump to the current price.

Risks

As always, there are some risks associated with MICC, or any investment. Besides the ever-present political risk of doing business in third-world countries, I think another important risk to take into consideration is the decreasing Average Revenue Per User. This key metric in the wireless industry has been decreasing by an average of about 15% each quarter over the last year. Likely due to the economic conditions, decreasing ARPU can significantly impact the profitibality of any wireless company (just as Sprint). Nonetheless, I think this risk is somewhat mitigated by the data usage penetration mentioned above. This product will help MICC offset this decline by providing a new revenue source. Futhermore, even with penetration at only 5%, the rate of ARPU decline has decreased in the latest quarter to less than 10%.

Bottom Line

With the strong business model and a history of delivering to shareholders, I think MICC is a strong bet if you want to take advantage of early-cycle emerging market growth. Even with the runup in the share price, I think the company has a conservative upside of at least 10-15% over the next year, and therefore, I think it's a good buy.

Revisiting the Motorola Play

In November of 2009, I wrote about Motorola and its attempted resurgance into the cell phone market (check out the articles here and here). The company had gone from a dominant player in cell phones with the RAZR to an also-ran with unappealing products and shrinking market share (which also resulted in a shrinking stock price that went almost as low as $3/share). However, with the introduction of the Droid and the palpable sense of negativity surrounding the stock, I thought it would be fair to give the stock another chance.

However, as was discussed in last November's posts, after looking into the DROID (both financially and physically) and keeping a close tab on sales figures, I was left unimpressed and didn't feel the DROID was a compelling enough product to justify the recent run-up in the stock price.

That was when the stock was around $9 a share. Today it's around $8 - underperforming the S&P 500 by 18%

Time For A Revisit

Although I didn't back Motorola as a pick late last year, I have been keeping an eye on the stock since then - I already did all this research, might as well keep up in case the situation changes. And recently, I've been seeing some serious signs of life for the DROID, and my philosophy is so goes the DROID goes MOT. With the introduction of the DROID X, Motorola has been building up steam in its smartphone marketshare, and in the cell phone business, marketshare is everything. As you can see below, MOT has seen a best-in-industry 136.8% growth in smartphone marketshare in Q1 2010. Granted that the overall marketshare is still pretty low, but I think that's already reflected in the stock price and nobody is arguing that MOT is starting from a difficult position.

The bottom line is that this is serious growth - the type MOT hasn't seen in a while. Furthermore, by parterning with Google's Android OS, MOT is building on what's arguably the best smartphone platform in the industry. In fact, in the first half of this year, Android smartphones outsold Apple's iPhone. Finally, keep in mind the numbers you see above are just for Q1 of 2010. Since then, the DROID X has been selling very well - a fact made apparent by the significant decrease in promotional by Verizon compared to the original DROID.

Translating that to Stock Price

The reason I'm focusing so much on this marketshare numbers is because MOT is aiming to make itself more of a smartphone maker and less of a 'run of the mill' handset maker. This translates to fatter margins that can be applied to the bottom line and a higher stock price. Right now the stock is around $8. It has had a pretty good fun with the good news coming out for DROID, but I think it can have at least another 10-15% upside with this continued momentum. Be careful, though. If you see any indication of market share momentum dropping, I would put a tight trailing stop. Coming back from the dead can be a slippery endeavour.

Jobs Jobs Jobs!

Over the last few months, when friends and family have asked me the all too common question on where I think the stock market is headed, I’ve had a pretty consistent answer – Jobs Jobs Jobs! Yes there are many other factors that come into play, including geopolitical uncertainties, economic growth from emerging markets, and housing prices. But to me, there’s one driving variable left in the market right now, and that’s the employment picture in the US.

Why I Think This

My reasoning behind this rationale is deceptively simple and can be summed up to a few bullet points:

• It’s the one area of the economy that hasn’t shown significant signs of recovery since the market bottomed in March 2009. The US unemployment rate has been stuck in the 9-10% range for a while now, while other indicators like productivity, household income, and manufacturing have improved at least modestly (yes, I know housing hasn’t improved significantly either, but I think the jobs is more the “cause” and the housing prices will be the “effect” in this scenario.
• This recession is markedly different than others because it’s the first time in many years that the US consumer has really cut back on spending. In past recessions, particularly the dot-com downturn in the early 2000’s, the consumer has been able to continue spending and, since this group makes up 2/3rds of economic activity, the recessions are able to be overcome fairly easily. With the unemployment rate being as stubbornly high as it is, the US consumer has severely cut back. Initially it was essentially all consumers that were cutting back. People were afraid of losing their jobs and cut back on non-essential spending. Although many of those consumers that didn’t lose their jobs have come back, there’s still a large contingent out there holding back on spending because they’re either unemployed, or have permanently adapted to a leaner lifestyle.
• Now that I’ve made the connection between employment and spending, let’s take it one step further to make the connection between employment and corporate spending. US corporations have a record amount of cash on hand. As the recession began, they also cut their own expenditure drastically. Corporations have refrained from spending most of this cash with the exception of increasing dividends to shareholders and buying back stock. However, real economic recovery requires that this capital be deployed and deployed effectively. To do this, companies need to see the biggest part of the economy come back to life – the consumer. And for that to happen, those consumers need to start working more. As you can see in the figure below, it’s a bit of a catch-22 – companies won’t hire until consumers start spending, and consumers won’t spend until companies hire them which requires those companies to spend that cash they’ve been hoarding. At the end of the day, once those people start getting hired, that’s when the real money will get back into the system and we can start seeing real GDP growth.
  

And Now the Bad News

Now that I’ve beaten the employment horse to death, here’s the problem. Last Friday, the government released it’s monthly employment figures which showed that companies hire surprisingly few people (83,000 vs. the expected 112,000). Keep in mind that this is the private sector employment number and that, overall, 125,000 employees LOST their jobs – mostly due to census workers being laid off as expected. Furthermore, the overall unemployment rate fell to 9.5% from 9.7%, but that’s likely due to the fact that fewer people are actively searching for jobs and, therefore, are no longer counted as unemployed.

But the real worrisome part here is that employment continues to be the nagging buzz-kill for the economic recovery. We still aren’t seeing the critical mass of hiring that is needed to spur some of the consumer spending increases and the subsequent capital deployment by private companies. The engine is sputtering and just not turning over.

Where to Invest Here

As you’ve probably noticed, the market has been down significantly the last few weeks. This is in large part due to pre-cursor signs of the economic troubles. Interestingly enough, when the actual employment numbers came out last Friday, the market was quiet and didn’t react either way. I think this was mostly due to the fact that investors already had an idea that this was coming as well as the upcoming long weekend. Therefore, I think this week will be a key indicator for the market on investor sentiment to the employment picture. It will either be perceived as a sign of more bad things to come and, hence, a longer term negative for the market (which I think is more likely) OR a buying opportunity since much of the downside may have already been priced in. It’s hard to say either way, but I’m watching the market like a hawk this week for clues on this enigma.

Long-term, though, I really think that an improving jobs picture is going to signal the next leg up in the stock market and the opposite picture will signal the next leg down. Like I said, many of the other economic indicators have been positive (although the factory orders number also came in with poor results which is cause for concern), so there is hope for a recovery here. We just need to get this employment engine revved up!

What are your thoughts?

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.

A Not So Electric IPO

In case you guys haven't heard, something happened in the stock market today that hasn't happened in a very long time. An auto company went public and listed itself on the NASDAQ exchange (in stark contrast to the auto companies that have be DE-listing themselves over the last couple of years). Tesla, the name that has become synonymous with rich and famous movie stars driving around $100+ all-electric cars is trying to raise money through an IPO to take its business to the next level. But before you begin clamoring for one of the most high profile IPO's since Chipotle, you need to look before you leap. All is not well with Tesla, and some things are weirder than other...

The Small Kid on a Very Big Block

The first and foremost concern I have about Tesla (TSLA) is the fact that it's in such an early stage in an incredibly competitive industry. The company has sold no more than 1,000 cars in it's history, and since its inception in 2004, it hasn't had a single profitable quarter. Now this may not be a huge deal for a company with a novel new technology that his incredible promise and can potentially landscape-changing for its industry (think Google or Dell back in its heydey). But, despite what you may think, Tesla's technology is hardly novel and far from promising. Several other, more established, names like Nissan and Chevy are vying to enter the electric car in the next 1-2 years. With their well-established supply chains, engineering muscle, and instant market credibility, they have the potential of pushing Tesla to the side and eliminating any first-mover advantage the California based company may have.

A Little Shadiness Thrown in There Too

Now I'm not the gossipy type, but when it's related to stocks, I think I can justify it. The founder of Tesla is Elon Musk - an entrepreneur whose claim to fame include founding Paypal and the X Prize. Now, you would think the founder of Paypal is a pretty wealthy guy. After all, Ebay paid $1.5 Billion for the online payment processor in 2002. But, there's a twist in the story. Mr. Musk is currently going through a messy divorce, and in recent filings, he states that he has spent his entire fortune on Tesla. As you may already know, issuing an IPO is a great way for the partners in a company to cash in the value of the company. Who's to say Mr. Musk isn't going forward with the IPO for more personal reasons to the detriment of his investors.

Tesla motors is a pretty hot commodity on Wall St. right now. It even had a great opening day - up 40%. But I do see some storm clouds on the horizon and would be weary of investing. The business model - assets made of promises and ideas rather than actual revenue and profits - smells faintly of the dot-com bubble. The fact that it is in one of the most volatile and competitive industries only exasperates the risk. On the other hand, if I'm wrong, there may be huge upside in the company. It is after all working on a sedan for approximately $50k to make the name more mainstream. Also, I even think it may be a good aquisition target for an automaker looking to jump start its electric vehicle program (Toyota has already invested a small amount in the name). But like I said, tread carefully.

What are your thoughts?

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.

It's About Time!!

It’s finally happened. Since the beginning of the financial crisis, there have been victims, criminals, and all around blame scattering. The reasons for this are obvious, and, in some cases, I agreed with the pundits, professors, and politicians (yes…even politicians…I did say ‘some cases’ after all) on where this blame was being placed. However, there was one sub-industry on Wall St. that was conspicuously missing from the scrutiny that the big banks and insurance companies were facing. Since the day I began understanding the mechanisms that caused the near collapse of Wall St., I wondered why this group was not at the center of it all.

Well, I’ll stop the teasing and tell you that the group is the Credit Agencies. I’ve always felt that these agencies, of which there are three major ones (Moody’s, Fitch, and Standard & Poors), played an integral role in the mistakes that allowed the financial crisis to occur. If you recall from previous posts, one of the root causes of the crisis were Mortgage Back Securities that were created by banks and sold to investors. Eventually, the quality of the mortgages that were being put in the securities dwindled drastically. However, investors continued purchasing them. Well, the credit agency’s role is to notify these investors of the quality of the mortgages. They put a credit rating to the security (much like the credit ratings you and I have), and that, in turn, allowed buyers to assess the riskiness of what they’re buying.

However, somewhere along the way, the credit agencies seemed to have gotten short-sighted because the poor quality mortgages that were put into the MBS’s were, in many cases, given good credit ratings, thereby providing investors with a false sense of confidence in what they’re buying.

As you can probably see, the credit ratings were really the checkpoint to make sure that the MBS market didn’t get out of whack like it did. I’ve been wondering for the last 2 years why their feet weren’t being held to the fire. But it finally looks like all that is going to change…

Finally – Some Scrutiny

I’m not going to get into the details of what scrutiny the agencies are now receiving. Although this may seem odd, there’s two simple reasons I do this: 1) I think the investigations are more politically motivated than anything and, therefore, it’s hard to say if there’s going to be any real changes coming out from them and, 2) This post is already long enough.

Nonetheless, if you’d like to learn about the investigations, take a look here

Where Things Should Change

Now that the ratings agencies are being combed over for their role in the crisis, I’m hoping there will be some wholesale changes in how they’re allowed to do business. The most obvious change that NEEDS to happen is their revenue structure. Right now, the agencies are hired by banks to provide ratings to the securities those banks are creating. The banks then generally take the best ratings and advertise those to investors. Well there’s obviously a gap here – the same people you’re supposed scrutinize are paying your bills! I think there needs to be some regulations put in place for how these credit ratings operate to eliminate these ovbvious conflicts of interest. Here’s my top 3 changes:

1. Create a pool to which banks will be required to contribute. This pool will then be used to pay credit agencies for their work and, knowing that their money is coming from the pool and not directly from the bank requesting the rating, the credit agencies is less likely to artificially inflate ratings.

2. Along with the first change, you also have to change disclosure rules so that ALL ratings for the security must be disclosed to investors so investors can have a full picture of the security’s risk assessment. To offset this, you can have the requestors of the credit ratings pay for each of the ratings.

3. Create a government regulatory group (probably within the SEC) whose sole function is to audit the Credit Agencies and ensure that they’re ratings processes are consistent and accurate.

I’m glad to see the credit ratings agencies being scrutinized for their role in the crisis. I find it surprising that a business model so entangled with conflicts of interest has been allowed to exist. The changes I’ve suggested, although fairly drastic, I think would be a great way to eliminate the conflicts inherent in the current system.

What are your thoughts?

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.

The Goldman Debacle - Part II

In my last post I used a casino analogy to describe the background of the SEC case against Goldman Sachs. Hopefully the analogy made the fundamental issue at hand a little clearer without the Wall Street jargon that confuses most of us common folk. But now that you understand the circumstances, you may notice the holes in the case and the somewhat flawed logic that the SEC is using to build what I think is a house of cards case.

It Can’t Be That Easy

First, let me tell you where I think the SEC’s case has merit. Basically, what the SEC is saying is that GS did not live up to its fiduciary duties by notifying investors that John Paulsen was shorting the mortgages in the CDO that it sold its investors. In a general sense, I think they’re right. GS, as the broker, should disclose as much relevant information as possible to its investors to ensure they’re interests are being served. And if it is apparent that GS violated this responsibility, they should certainly be punished for it.

That’s it. That’s the only area where I think this case has merit. Now, with that out of the way, let’s discuss where it doesn’t have merit. I think the biggest flaw in the SEC’s logic is that they’re saying that GS should have disclosed the person on the other side of the trade (i.e. Paulsen).

Stop right there and think about that. Say you were the casino in my example. When you see those gamblers come and bet money, isn’t there an assumption that those gamblers know that there’s someone on the other side betting against them. In any gamble, whether in a casino or Wall Street, there are two sides to every gamble. In the casino, we call that the ‘house’. On wall street, it could be anyone that feels the opposite of what your bet is.

In other words, every time you bet on an asset, whether it’s a CDO or a stock or you double down on a hand of Texas Hold ‘Em, there is an implicit counter-bet. If everybody felt that the mortgages in the CDO would go up like the investors that bought them did, why would anyone sell them? Furthermore, does it provide any additional value to the buyer if they were explicitly told who the counter-party on the CDO is? I don’t think so. When I buy a stock, I know someone is selling it to me. Will it change my decision if I knew who is selling the stock I’m buying? If I’ve done my proper due diligence, it shouldn’t

The bottom line here is that I feel that Goldman did not have a fiduciary responsibility in not disclosing that John Paulsen is betting against those mortgages because it wasn’t relevant information that the buyers needed to know – it’s just not common practice on Wall St. to do that. Furthermore, the fact that the actual buyers of the CDO were banks who are sophisticated enough investors to perform the necessary due diligence only reinforces this notion.

Where Do We Go From Here?

Honestly, I think the SEC’s case against GS is a witch-hunt to a large extent. The SEC has come under a great deal of scrutiny lately for allowing the financial collapse to occur under their watch, and, unfortunately, I think this case is them trying to pander to the public and Washington that they are still relevant. Hopefully, in time this case will be dropped. However, I think the more likely scenario is they’ll settle with GS out of court and we can move on.

What are your thoughts?

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.

The Goldman Debacle - Part I

Well folks, here we go. The fallout from the housing crisis is beginning to hit the biggest players in the industry. A few days ago, the SEC (the government organization tasked with policing the financial industry) formally filed a civil lawsuit against what was until then perceived to be the proverbial Iron Man on Wall Street – Goldman Sachs. In the lawsuit, the SEC basically accuses GS of intentionally misleading clients who invested in a product that the bank sold them. The ramifications of this can potentially be huge, and this is likely only the first shoe to drop in a series of lawsuits. But I wanted to take a look at exactly what’s going on, how I think it’ll play out, and, in true InvestingDecoded fashion, how you can potentially profit from it.

Place Your Bets

Exactly what events allegedly transpired to put GS in this situation is kind of tricky to explain. What I’d like to do is set up the scenario without using financial jargon that’ll just end up confusing most people. Let’s set up a real world scenario that parallels the SEC allegations:

Say you own a casino, and a man, let’s call him Mr. Paulsen, comes to your casino and asks you to put a specific model slot machine into this casino. The slot machine Mr. Paulsen is asking to put in the casino is well known to gamblers at the casino as it has historically given healthy pay-outs. Basically everyone who plays on that model slot machine has been winning money. But Mr. Paulsen thinks differently – he thinks that the slot machines are overrated and will eventually stop paying out healthy gains and gamblers will lose money. So he asks you to put the slot machine into your casino so he can get as many gamblers possible playing on it and make money once it stops paying out the cash.

Well, you as the casino owner agree to do it. But before you do that, you want to make sure the slot machine isn’t broken or tampered with. You hire an outside contractor to come inspect the casino to make sure it’s OK. But the vendor, NOT knowing that Mr. Paulsen is convinced the machine will stop paying out, OK’s the slot machine assuming there’s no conflict of interest between Mr. Paulsen and the players.

So you put the slot machine on your casino floor and gamblers clamor to play on it. But you don’t tell them something key – the person who asked you to put the machine there is convinced that you’re going to lose money. Now, as a gambler if the guy who had the clout to get that slot machine on the floor is convinced that the slot machine is overrated an will eventually stop paying out, wouldn’t you think twice about playing on the machine? However, as the casino owner, you don’t disclose this fact to the players. All you do is put a sign on the slot machine saying it was inspected by a third party and it works fine.

Low and behold, the machine stops paying out. Gamblers keep playing and keep losing money and walk away empty-handed. In the mean time, Mr. Paulsen reaps in the rewards from the gambler’s money, on the order of $1 Billion, and you the casino owner keep a share for your services.

This, in a very small nutshell, is what happened in this case. But the casino is Goldman Sachs, the slot machine is Collatorized Debt Obligation (basically a package of mortgages that investors can buy/sell, see past posts for more details) and the gamblers are investors. Furthermore, Mr. Paulsen is actually John Paulsen, a hedge fund manager who correctly bet against the housing market in 2007 and made billions of dollars. What Mr. Paulsen did was ask GS to create a CDO with mortgages that he thought were not as strong as they were perceived to be. He did this by analyzing the quality of these mortgages and comparing them to the credit rating given to them by the big credit rating agencies. The ones that the thought were literally overrated he wanted GS to put in the CDO. GS then hired ACA Management as an independent reviewer of the assets in the CDO (i.e. the independent contractor in the analogy). ACA was tasked to review the mortgages Mr. Paulsen requested to be put in the CDO. But what ACA didn’t know was that Paulsen was holding a short position on those very mortgages.

GS then took the CDO and sold it to investors (mostly foreign governments and banks). But GS didn’t disclose the fact that the person who selected the mortgages in the CDO thinks they’re going to collapse. Do you see the issue here? The bottom line, the SEC is accusing GS of creating a product and selling it to investors while not disclosing the entire story.

You might be thinking that this is a grey area of disclosure, and you’d be correct in thinking this. In my next post, we’ll discuss the holes in the SEC’s case, and how I think the story will play out.

What are your thoughts?

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.

Another Big Airline Merger?

That's right, folks. Here we go again. The rumor mill on Wall St. is buzzing with yet another big airline merger. After the surprisingly successful merger with Delta and Northwest, it looks like United and US Airways are discussing tying the knot...again. The combination would create the world's second largest airline (behind the aforementioned Delta/Northwest combination) with large operations in virtually every corner of the country (San Fran, Phoenix, DC, Chicago, Philly). But, at the same time, I think it might cause some headaches as well.

History Repeating Itself

This isn't the first time United and US Air have tried to get together. In 2001, the two airlines had a merger agreement that was shot down by the US Justice Dept. on antitrust grounds (ironically enough, both airlines declared bankruptcy a couple of years later). Nonetheless, the two airlines do have some synergies that make a merger sensible. A complimentary route structure, a decent amount of fleet overlap, and the same alliance affiliation would all make a merger makes sense. Furthermore, US Airways has a history of financial under performance and, to shareholders, it may make good sense to combine with a bigger competitors.

Industry Tailwinds

Another good argument for industry consolidation is pricing power. There were two major components of pain for the airline industry this decade which resulted in billions of dollars in loses - higher costs (mainly due to oil prices rising) and lower ticket prices. Because of the huge expansions over the years, the major airlines needed to lower prices to compete. The conslidation of a United/US Air would reduce this competition and allow airlines to increase revenue.

Of course, this is a double-edge sword. Increased pricing power means higher fares for you and me. As much as it might be painful, in my mind it's an inevitability that has already begun.

But of Course There's a Twist

Although there does appear to be serious merger discussion between the two carriers. There are thoughts that United is talking to US Air as a negotiation tactic with another airline - Continental. United has also been courting Continental for a some time now, but the Houston based carrier has refuted offers. The prevailing thought is United is hoping to bring Continental back to the table when it feels that it might be at a disadvantage with a United/US Air tie up.

In other words...stay tuned!

How to Trade Through This

I've said in the past and I'll say it again...I never recommend investing in airlines long-term. However, in this case, I do think there are some opportunities for TRADING through this news (i.e. short term investing of 6 months or less). But I wouldn't buy any of the names involved in the mergers here, there's others that I think can benefit:

1. Alaska Airlines - The airline's size and market niche make it a perfect takeover candidate - especially for American Airlines. Another big merger might force AMR to make a move as well, and Alaska could be a great catch.
2. JetBlue - The airline has had some rough patches, but pricing power could bring some positive upside for the airline.
   

The airline industry is extremely dynamic and full of surprises. Stay tuned to InvestingDecoded for the latest updates and what they mean to you. Of course, you might also get some ideas on how to invest in it.

What are your thoughts?

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.

A Portfolio for the New World of Health Care

As I’m sure you’ve already heard – the landmark Health Care reform legislation was recently signed into law by President Obama. Regardless of your viewpoints on this reform (and I’m sure everyone has their own opinions), this is arguably the most impactful piece of legislation of our time, and with it comes major changes to the companies involved in healthcare. As I’ve said before, with change comes opportunities, and in true InvestindDecoded fashion, I wanted to discuss what investing opportunities this legislation brings about.

The Low-Down

A few months ago, I wrote about the reform when it was still in its negotiation stages. At the time, I gave my viewpoint on how you could invest in the reform. Now that we have an idea of what the final legislation will look like, I will revisit those predictions and see if they still hold up. Before we can do that, however, let’s take a look at some of the key points of the legislation:

· The primary goal of the legislation is to provide affordable health coverage to some 32 million additional Americans.

· State-based insurance exchanges will be created to enable the uninsured, small businesses, and self-employed to create ‘groups’ through which they can purchase insurance at a lower cost than if they tried to purchase it individually.

· Most larger businesses (those with 50 or more employees) will be fined $2,000 employee/year for not providing coverage for all employees.

· Uninsured individuals who do not purchase coverage will be fined $695/year.

· There will be cuts made to Medicare reimbursement but additional coverage made for Medicaid.

· Insurance companies will no longer be able to deny coverage based on pre-existing conditions or drop coverage for members who get sick.

Winners and Losers

Overall I think that this final legislation is not all that different from the proposed legislation I discussed a few months earlier. There seems to be some distinct winners and losers and, although many of the winners have already seen their stock prices rise significantly, I still think there’s long-term upsides.

Winners

· Pharmacy Benefit Managers – In my mind, these guys are the real winners here…big winners. My prediction is that there will be serious emphasis put on cost-containment for health coverage. Now that coverage is more of a commodity and less of a luxury, margins will be squeezed for insurers. Therefore, they will be looking to save every dollar they can. PBM’s are the ideal way to save money on prescription medication for these insurance companies. I think names like Express Scripts and Medco will see some serious upside. However, one that I think will be the clear winner in all this is CVS Caremark, who I think will win on both the PBM and Retail pharmacy side.

· Pharmaceutical Companies – Drug companies came away like bandits in this legislation (I’d say this is thanks to some nifty deal-making with the government early on in the legislative process). These companies will see an influx of 32 million new customers that would previously not buy their products. On the other hand, they have come back with token concessions as payment for the new demand. Right now, there doesn’t seem to be a single big winner. A pharma ETF would be a perfect investment here.

Losers

· Health insurance Companies – The health insurance industry has just been turned on its head. These sweeping reforms will impact the likes of WellPoint, Aetna, CIGNA, United Healthcare, etc. drastically. The first challenge I see for them is increased cost due to the types of members they will now have to insure (i.e. those who are extremely sick and would otherwise not be able to get coverage). Furthermore, they will face increased competitive pressures due to the exchanges that were set up as well as opening up the market to more competition that was done through previous legislation. Yes there are now 32 million new potential customers. But I think the pricing pressure and increased cost structure will their once-lofty margins and, consequently, shrink profits.

My Reform Portfolio

With all this said, I have a simple portfolio that I’d recommend for reform. Now keep in mind many of these stocks have already had a significant run-up and may experience some near-term weakness (next time listen to my recommendations that first time I make them). But I think long-term there’s still opportunity here. This portfolio will give you a fairly diversified healthcare setup while taking advantage of the true winners (as I predict they will be):

1. 25% - CVS Caremark

2. 25% - PBM ETF (to diversify in case things don’t go well for CVS)

3. 30% - Pharmaceutical ETF

4. 20% - Biotech ETF (to get more leading edge pharmaceutical exposure)

What are your thoughts?

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.

You Can Now Bet on Movies!

In the spirit of the 82nd Oscars (which I may or may not be watching as I write this post), today I want to discuss a novel new investment vehicle that I recently heard about.

We've discussed Options investing here on InvestingDecoded in the past. The basic idea is that you create a contract whose worth is based on the intrinsic value of a hard asset (i.e. it's value is derived from the value of a hard asset...i.e. a derivative). Recently Cantor Fitzgerald, leading financial services company, announced that it has received approval from the CTFC to create an market exchange for Options based on movies.

Huh?

Known as the Cantor Exchange, this new market will allow investors to bet on the box office success of movies. Investors will be able to invest in options for upcoming film releases. Each options will price at one-millionth of the expected gross ticket sales of the movie 4 weeks after release. That means that if the market is betting a movie is going to make $100 million dollars after 4 weeks in the box office, the option contracts will price at $100. As the expected 4 week gross revenue number changes, the contract price will adjust accordingly.

What's the Impact Here?

The ability to trade the success of movies provides more than just a betting market where you and I can prove how much we know about good movies (although it does that too). The Cantor Exchange will provide a marketplace for moviemakers to hedge their risks when financing movies. There has been a strong and consistent trend in Hollywood to bring out pricier and more extravagent films. Having an exchange where you can gauge the success of a project you've funded gives moviemakers the opportunity to long or short options for their movies. That way they can reduce their exposure if the movie is not a commercial success. This also gives opportunities for low budget filmakers access to more capital as they'll be able to write Option contract for they're films and have access to a greater number of investors through the Cantor Exchange.

But All's Not Well

I think the concept of the Cantor Exchange is really interesting. It's bringing investing principles to filmaking to a level at which it has never been. However, I do see some serious risks with this exchange. One of the most important principles in investing is the equal dissemination of information to all potential investors. In other words, if one investor knows something, all of them should - otherwise you get the chance of insider trading. The risk I see with the Cantor Exchange is that film producers can gauge the potential success of a movie prior to its release and start trading options on it while other investors haven't had the opportunity to see the movie. However, I think that is a very fixable situation. There are very strict regulations on how CEO's of publicly traded companies (as well as others with 'material insider information') can trade the stocks of those companies. These same rules would need to be applied to studios and those at the studios with that type of information. With these rules in place, I think the Cantor Exchange can be a really interesting and lucrative endeavor for all of us individual investors.

Learn more about the Cantor Exchange here

What are your thoughts?

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.

Clearwire (CLWR) - An Interesting Play

Recently, a friend of mine asked my thoughts on a stock whose products have been getting some strong exposure lately. Clearwire, a growing name in the wireless broadband arena, is attempting a major coup in the broadband internet industry. Through it's Clear brand, it's trying to lure people away from traditional broadband providers (cable, dsl, phone, etc.) into wireless broadband. If you're from Chicago, you've probably seen the ads around the city.

The Technological Advantage

When chatting with my friend about CLWR, the first question I asked was "How do they expect to compete with names like Comcast, AT&T and Verizon? These big names have huge market penetration already and switching costs can be fairly high for something as integral as internet service."

My friend explained that the key with CLWR is it's technological advantage. All of its wireless broadband service is 4G. Clear claims its 4G service is 4X faster than the current 3G used by the major names. CLWR is achieving this by partnering with Sprint's wireless network which has already been implementing the 4G network for over a year now. On the other hand, the big wireless providers (i.e. Verizon and AT&T) are at least 3-6 months behind in implementing 4G.

This technological advantage gives CLWR the edge in providing a better product than its competition which will help it lure customers away. Having fast wireless internet service anywhere in the city at a competitive price can really help CLWR get the market penetration it needs to be successful.

But The Stock Can Be a Different Story

One of the first things I learned when I started investing is, often times, comparing a company and its stock can paint two very different pictures. CLWR's product looks promising. They seem to be on the right track of changing the landscape of broadband internet. However, the stock looks more iffy and I'll explain why:

1 - Valuation - CLWR's stock is being very richly valued by investors. The price/sales ratio of 5.79 is almost 5X the industry average. A richly valued stock is usually appropriate for high growth companies like CLWR. But 5X I think is pushing it.
2 - Earnings History - After a fairly stable 2008, earnings for CLWR have been increasingly negative for 2009. This is most likely due to an aggressive expansion strategy. Nonetheless, losses are expected to continue their declaration this year.

However, even with these negative components, all hope's not lost. The company has a strong cash base of $1.96 Billion which is enough to cover all its debts. That helps offset the negative earnings. Furthermore, the recent pulback of the stock price has helped reduce the rich valuations, although it's still on the expensive side. Finally, insider buying/selling is pretty neutral, which helps bring confidence that management isn't at least getting out of the stock.

A Mixed Bag

CLWR has a lot of things going for it at this point. However, at least in the short term, I don't think this is the best time to buy the stock. I see continued downward pressure over the next few months. However, long-term, I definitely see strong growth for the company. Analysts are expecting a 92.7% increase in year-over-year sales growth for 2010. That's a tall order for any company. However, I think CLWR is taking the right steps to get there. Furthermore, I think CLWR can potentially be a takeover target by one of the big guys if they decide they want to get a head start in the 4G business.

Bottom Line

I would buy CLWR for a long-term investment. However, I'd first wait until valuations come more in line. It needs to get down to at least $5.50 before I seriously think about getting in. $5 would be a perfect entry point. From that point, I'd keep a close eye on the revenue growth (not so much profit numbers) and, as long as its consistent and meeting expectations, hold on for the ride upwards!



What are your thoughts?

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.

2009 Year In Review

2009 has come to an end and, thus, ends the first year of InvestingDecoded. I started this blog to help others learn about investing and try to make sense of something as complex as the stock market. I hope I've been able to make this happen. At the same time, however, InvestingDecoded has helped me learn more about investing for myself. To me, that alone has made the time worthwhile.

Now that the first year is over, it's time to look back. One of the biggest things every investor needs to do a assess his/her performance. InvestingDecoded is no exception. Let's take a look back at topics I've covered and see how the recommendations have performed.

Oil's Rollercoaster Ride

Early last year, I wrote a series of detailed posts about the oil industry. We discussed how the oil complex functioned and the price drivers. One of the big recommendations I made was a call on oil prices. When I originally wrote the post, oil was hovering around $35 a barrel. I wrote that the $35 price was artificially low and, eventually, prices would rebound. At the end of 2009, oil was trading at close to $80, slightly above my estimate of the mid-70s. If you had invested in oil when I recommended it, it would have been a fruitful investment.

The Banking Crisis

InvestingDecoded also had a series of banking related posts. Here, we peformed a detailed analysis on the balance sheet of various banks. From there, I ranked what I felt were the best banks to invest in, with Wells Fargo coming out the winner. Looking back at this prediction, it seems that I was likely somewhat off. WFC has slightly underperformed the overall industry ETF (graph below). Although I'm still convinced the bank has good days ahead of it, many of the pureplay investment banks (e.g. Goldman Sachs) have performed better.


International Telecom Getting the Job Done

One of my more direct recommendations last year was Millicom International. The emerging market cell phone company was trading in the 40's. Now trading in the mid-70s, Millicom has shown it's quality as a company and a stock. I still think the company has room to grow to the 100+/share once global growth really picks up.

Other Names

Some of the other names I discussed were companies like Ford and Citigroup. Since those recommendations were made later in the year, it's hard to assess their success. Ford, however, looks like it's doing very well. I personally have made a nice 70% return on it and have cashed out some profits. Citigroup is having some issues, but it wasn't a outright recommendation when I had discussed it. Time will tell how both these once-powerhouses come through in this recovery

2009 was one of the most interesting years to be an investor. You could have made a lot of money if you took some risks. At the same time, you could've lost a lot as well. 2010 I think will be less volatile, but it will set the tone for the next few years. I'll keep on making recommendations in 2010. Here's to all of us having some success :-)


What are your thoughts?

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.