Equity One Inc (EQY)= $7,755,627
World Acceptance Corp (WRLD)= $2,374,380
Cousins Properties Inc (CUZ)= $ 1,479,383
Hercules Offshore Inc (HERO)= $1,404,247
Nuveen Municipal Value Fund Inc (NUV)= $1,393,820
Nuveen Global Value Opportunities Fund (JGV) = $1,368,600
Neuro Hitech Inc (NHPI) = $1,326,750
Osiris Therapeutics Inc (OSIR)= $1,237,000
Aca Capital Holdings Inc (ACAH )= $1,214,080
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Mr. Whitman’s thoughts on the mortgage situation are just spectacular and more than worth the time to read. I get the letter by being a holder in the Third Avenue Value Fund (TAVFX)
THE RESIDENTIAL MORTGAGE MELTDOWN AND HOUSING COLLAPSE
TAVF is investing heavily in the common stocks of companies suffering through the current housing crisis. These companies include financial institutions, a home builder, a building supplier, land banks and investment builders. The Fund’s reasons for this investment program provide a good case study as to how Third Avenue’s “safe and cheap*” approach works in practice:
First, the bad side of these investments:
1) The stock market pricing for these equity issues ischaotic. There is no way Fund management is able to pick a bottom for securities prices, or a near bottom.
2) Fund management has no good idea of how deep the crisis will become, or how long it will last. Our best guess is two to four years.
Second, the good side of these investments:
1) In each instance, TAVF is acquiring common stocks at meaningful discounts from readily ascertainable NAVs. In the case of certain financial institution common stocks – MGIC Common, MBIA Common and Radian Common, the prices the Fund is paying are no more that 40% of book value, or adjusted book value. For each of these companies, a normalized Return on Equity (equity equals book value) (“ROE”) ranges from 8% to 14%.
Assuming a 10% ROE sometime in the future, and no further dramatic deterioration in book value during the interim, probably a realistic assumption; and current pricing at 40% of book value, Third Avenue would be paying only four times future normalized earning power. There seems to be a reasonable probability, too, that TAVF is really paying less than four times normalized earnings, even assuming that future normalized earnings are fully taxed and even assuming some modest dilution of the common stocks.
2) Each common stock acquired, is acquired in a company which enjoys a strong financial position. While there can be no guarantees, the probabilities are that each of these companies will survive as solvent going concerns either without requiring major access to capital markets for new funding, or by obtaining new funding from others on terms that are only modestly dilutive for TAVF. On December 10th, MBIA announced that it is obtaining $500 million of equity financing from Warburg Pincus; and another $500 million from a rights offering which Warburg Pincus will backstop, i.e., underwrite. Assuming that Third Avenue participates in the rights offering and also takes advantage of any oversubscription privileges, the capital infusion should be, at worst, only modestly dilutive for TAVF.
3) Each company seems very well managed.
4) It is possible that the crisis will become increasingly deep, and prolonged; or rating agencies will start to place great weight on soft, qualitative considerations. In those events, the companies might need capital infusions to remain going concerns. TAVF has proposed to MBIA, Radian and USG managements that such infusions be in the form of equity, and that existing stockholders provide the equity via pre-emptive rights offerings. MBIA proposes to raise $500 million via a rights offering. If this were to occur, and if other portfolio companies were to follow the MBIA path, the capital infusions would be, for Third Avenue, mostly nondilutive, or anti–dilutive (if there are oversubscription privileges).
In the case of MBIA and Radian, it is crucial if they are to remain going concerns, that the national rating agencies continue to assign AAA and AA ratings, respectively, to each company’s bond insurance subsidiaries. As an aside, given current prices, TAVF would probably not lose money if Radian or MBIA were to go into run-off rather than remain going concerns. Run-off, i.e., liquidation, simply is not a likely outcome, however. It would appear as if capital infusions would not become necessary if the rating agencies were to rely on only hard, quantitative data.
However, this month, Moody’s announced that in reviewing ratings it would also consider soft qualitative data, much as Moody’s views as to what “investor perceptions” are. Consideration of such qualitative factors as investor perceptions seems to increase the probabilities that Radian might seek a capital infusion as was the case for MBIA. At December 21st, TAVF owns 12.9% of the Radian Common outstanding, and 8.0% of the MBIA common outstanding.
At current depressed prices, the Fund would rather buy common stocks from the companies than from company stockholders. If rights offerings were to become available not only for MBIA, but also others, TAVF might have attractive buying opportunities. In analyzing each of the financial institutions, Generally Accepted Accounting Principles (“GAAP”) tend to be quite misleading. This is because GAAP require that derivatives such as the Credit Default Swaps be marked to market – and market prices now are highly capricious, to say the least.
Marks to market are the most appropriate, and helpful, tool in the appraisal of publicly-traded common stocks held in trading portfolios. Marks to market are an inappropriate, and unhelpful, tool in the appraisal of credit instruments held in portfolios where the intent is to hold the credit instruments to maturity. MBIA and Radian intend to hold their credit instruments to maturity. Third Quarter 2007 mark to market losses recorded by MBIA and Radian were as follows:
Mark to Market Losses,
MBIA $222,000,000 / $1.80 PER SHARE
Radian $404,000,000 / $5.02 PER SHARE
Further, MBIA announced on December 10th that its mark to market losses for the fourth calendar quarter of 2007 will be significantly greater than they were in the third quarter.
The real losses to MBIA and Radian will be determined not by marks to market, but by
(a) the percentage of the portfolios that suffer moneydefaults, plus
(b) how those money defaults work out after recoveries from foreclosures, restructurings, refinancings and reinvestments.
MBIA’s fourth quarter 2007 reported losses will be staggering. In addition to mark to market losses, the preliminary indications are that case reserves will be increased by $500 million to $800 million pre-tax. The Company, however, will remain with a quite strong capital position. When I first trained as an analyst – some 50 plus years ago – the primary role of GAAP was to meet the needs of creditors who held credit instruments to maturity. That’s all changed now.
The primary role of GAAP seems to have become to fulfill the perceived needs of equity holders who are vitally affected by day to day changes in common stock prices. As I’ve pointed out in previous letters – What a waste! GAAP can’t really be very useful to stock market speculators, but it can hurt issuers like MBIA and Radian. In any event, TAVF, as a “safe and cheap” investor, will continue to place primary weight on “what the numbers mean” rather than on “what the numbers are”.
Though I feel very good about our investing program into U.S. housing related companies, TAVF is hardly “betting the ranch” on such investments. At October 31, the Fund had $1 billion, or 8.3% of its net assets, in such investments. In contrast, for example, the Fund had $3.2 billion, or 26.2% of its net assets, invested in the common stocks of Hong Kong-based companies involved with real estate and private equity.
Over the years, TAVF has been rather successful in distress investing, the recent Collins & Aikman debacle notwithstanding. The key to most of the distress successes was the Fund successfully indentified, and acquired at bargain prices, the fulcrum security of the troubled issuer, i.e., the most senior security which would participate in a reorganization. Our current housing crisis investments are very much like our other distress investing (e.g., Nabors Industries, Covanta, Kmart, USG) except here the fulcrum security investment is common stock rather than credit instruments. To push the analogy a little further, as a return to normal times occurs, it appears as if the common stocks either will be reinstated (i.e., the capital invested will remain intact) or that there will be a reorganization (i.e., companies will need capital infusions.) A principal risk to the Fund could occur if the businesses seek capital infusions, and if such infusions are on a basis that would be highly dilutive to existing stockholders.
Historically, financial guaranty insurance has been a highly profitable business for the monoline insurers, even though the insureds received a very attractive deal by being able to obtain AAA ratings at low cost. Insurance company profitability is measured by a combination of underwriting profits and net investment income. Underwriting profit is measured by the “combined ratio”, i.e., the ratio of the sum of losses and expenses to net premium income and net premiums written. Net investment income, usually all interest income, tends to be larger as long as loss liabilities are “long tail”, i.e., the losses do not have to be paid out until long after the insurance premiums have been collected and then invested in bonds.
Typically, MBIA’s insurance subsidiaries have enjoyed a combined ratio each year under 40%. Net investment income for the MBIA insurance subsidiaries has grown over the years to almost $600,000,000 per annum. The prospects appear quite good to Fund management that, once past the current housing difficulties, MBIA will return to its historic patterns of very attractive combined ratios and relatively steady growth in net investment income.
The mortgage meltdown-housing collapse seems nothing new for the U.S. economy. During the last 60 years, virtually every sector of the American economy has gone through depressions as bad as anything that occurred in the 1930s. Remember the melt-downs during the past 40 years for, inter alia energy, banks, real estate, savings & loans, Wall Street brokerages, row crops, steel, automobiles, machine tools, etc. Unlike the 1930s, all these depressions occurred without domino effect. The probability seems to be that the next ten years in the U.S. will be more like the last 40 than they will be like the 1930s. Put otherwise, the odds favor overcoming the current crisis in residential housing and residential housing finance without underlying damage to the U.S. economy.
Martin J. Whitman
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I have an interesting question about the group.
1. www.walmart.com (WMT)= 7.94%
2. www.target.com (TGT)= 5.06%
3. www.bestbuy.com (BBY)= 3.96%
4. www.sears.com / www.kmart.com (SHLD)= 3.72%
5. www.circuitcity.com (CC)= 3.07%
6. www.jcpenney.com (JCP)= 2.03%
7. www.toysrus.com (private)= 1.97%
8. www.macys.com (M) = 1.43%
9. www.kohls.com (KSS)= 1.3%
Data from Hitwise
The question? How in all that is holy can Circuit City be losing money? They have been in the top 5 all season and are currently the only one of the group losing cash. Pathetic comes to mind…
Wal-Mart has commanded essentially a 3% lead over #2 Target all fall. Now, with Target announcing a recent December sales disappointment, this 3% may be the difference for Wal-Mart being successful this holiday season. When you add Wal-Mart advertising of its very popular “site-to-st0re” program and Target’s lack thereof, a hard lesson may have been l;earned by Target execs this season.
What will be interesting is to see results from Sears Holdings which has a similar program but did not advertise it as hard..
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Today, Macy’s (M) announced they are closing nine underperforming stores, citing declining sales with no identifiable growth opportunities.
The store are located at: Washington Square, Indianapolis, IN; Prien Lake Mall, Lake Charles, LA; Rolling Acres Mall, Akron, OH; Canton Centre, Canton, OH; Randall Park Mall, North Randall, OH; Crossroads Mall, Oklahoma City, OK; Valley View Center, Dallas, TX; Sharpstown Center, Houston, TX; Family Center at Riverdale, Riverdale, UT.
This is just lousy. They could not wait a week? It is especially repugnant when just a few weeks ago Chief Executive Terry Lundgren said, “We always go through the normal process of pruning our real estate portfolio, but there are no plans for a wide-scale closure of stores.”
Nice…….
On another note, retail is must suffering currently. This will make the results Wal-Mart (WMT) turns in Jan. 10th even more impressive.
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WM Washington Mutual Inc 13.09
WEN Wendy’s International … 26.26
TLB The Talbots, Inc 11.93
TIN Temple-Inland Inc 29.51
PFCB P F Chang’s China Bis … 22.76
PETM PETsMART Inc 23.77
MSO Martha Stewart Living … 8.84
MDS Midas Group Inc 14.97
MAT Mattel, Inc 19.12
JBLU Jetblue Awys Corp 5.98
FIG Fortress Investment G … 15.47
FIC Fair Isaac Corporation 32.42
FDX Fedex Corp 90.39
CC Circuit City Stores, … 4.17
C Citigroup, Inc 29.22
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Citi (C) CEO Vikrim Pandit has already commented on the dividend issue and as far back as early November I commented that I felt it would not be cut. Despite recent reports like the Goldman Sachs (GS) estimate of a 40% cut, recent events have only buffered my feelings on the subject.
Currently Citi pays just under $11 billion a year in dividends. Sounds like a lot until you consider in the last 12 months Citi earned almost $24 billion. My guess is that Pandit had no desire to be the guy who cuts the dividend. It would be construed as taking the easy way out, rather than trying to actually fix Citi’s issues. I have said repeatedly in the past he has $2.3 trillion in assets under his control and can easily sell chunks of them to raise capital if he needs it.
Thursday the Wall. St. Journal reported that Citi is looking at doing just that. Units rumored on the block include Student Loan Corp., which is 80 percent owned by the bank, its North American auto lending business, the Brazilian credit card company Redecard SA, in which Citigroup held a 24 percent stake as of Sept. 30 and its Japanese consumer finance business.
Pandit’s also is laying off about 20,000 employees as he streamlines operations. Now, the current list of items for sale is just the beginning and the “low hanging fruit”. In his first interview as CEO Pandit did say regarding possible asset sales “all options are on the table”. He was far less open to a dividend cut saying “the board has spoken on that and the dividend is where it is”.
Do I think the dividend will be raised in 2008? not by a long shot. But sitting here getting over 7% taxed a 15% is a real nice deal while we wait for this thing to shake out.
Financials are a huge opportunity here, for investors with the right time frame and temperament.
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Friday’s Picks
Karen Finerman recommends being short the iShares Dow Jones US Real Estate ETF(IYR). Open $66.48
Guy Adami likes Intel (INTC). Open $26.83
Pete Najarian says investors should buy Archer Daniels Midland (ADM). Open $46.04
Results since 6/21/2007:
Guy Adami= 57-45 = 60%
John Najarian= 13-4 = 76%
Jeff Macke= 60-40 = 66%
Pete Najarian= 48-40 = 57%
Tim Seymore= 7-7 = 50%
Karen Finerman= 38-30 = 56%
Stacey Briere-Gilbert= 3-0 = 100
Ned Riley= 1-0 = 100%
Carter Worth= 0-1 = 0%
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For those who do not know who Todd Harrison is, you should. He is the founder of Minyanville.com. He has an article on 2007’s top 10 themes. It is a great read.
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There has been a ton of speculation as to what Dow Chemical (DOW) was going to do with the $9.5 billion it is getting from Kuwait in the recent JV agreement.
Some backround:
On 12/7 I wrote “How about using the very same strategy they have been using for the past year? Selling chunk of this business to outsiders and placing them into the Joint Venture (JV) category. This would provide Dow billions of dollars instantly to be deployed in buying some specialty chemical makers without impairing the balance sheet.”
A week later Dow announced it has sold 5 of those very commodity businesses into a new JV with Kuwait and would receive $9.5 billion for them AND still receive a 50/50 split of the businesses results.
Where is the money going?
Dow Chemical plans to invest $5 billion in China in the coming 10 years, said CEO Andrew N. Liveris in Shanghai yesterday. The $5 billion fund budget will not cover a potential coal-to-chemical project in central China’s Shaanxi Province, where the chemical giant is conducting a feasibility with Shenhua Group Corp, the world’s second largest coal producer, added Liveris.
Now that is has signed the agreement with KPC (Kuwait Petroleum Corp.) Dow is in talks with Sinopec (SHI) to take over stake in the refiner’s $5 billion joint venture oil refinery and petrochemical project with Kuwait Petroleum Corp in East China’s Guangdong province.
China welcomes chemical producers from Kuwait and Saudi Arabia because they are able to provide crude oil to the country’s large petrochemical projects, said Wang Jin, an analyst at Orient Securities recently.
Dow is on a path to be the world’s dominant petrochemical producer. Early this year CEO Andrew Liveris called 2007 “a transformational year”. He has delivered.
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Dumbest moments, Bill Miller, Standardized Tests, Bloggystyle.
– Here they are, the 100 dumbest business moves of the year.
– A very interesting interview with Bill Miller.
– We need them. It is the only way to compare. Life is about being tested, might as well learn how to deal with it.
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In early November, Blockbuster (BBI) CEO Jim Keyes said “Are we raising prices? No, as of today, what I don’t want to do is raise them three or four times.” Well guess what?
Blockbuster is boosting prices of its DVD-by-mail service for new customers and some existing ones by up to 40 percent. This mean hikes of $2 to $10 depending on “the profitability of the individual subscriber.” Back in June when Blockbuster lowered the prices in a desperate attempt to steal business away from Netflix (NFLX), I simply said they could not maintain the prices because their cost structure was so much higher than that of Netflix.
I said if they wanted to compete on price with their rival, they need to close more stores to lower the basis.
Of the new plan, Blockbuster spokeswoman Karen Raskopf said they are “a really good value for consumers” that are “providing a fair return to Blockbuster.” She said the company hopes the increases won’t cause existing subscribers to quit. “This is not a plan to drive people away,” she said. “We want to keep them all.”
Raising prices is not usually a recipe for keeping customers. Although, Blockbuster has been losing ground on Netflix for the past year so I guess if they just tread water, they will be happy.
At the end of the day this all boils down to the stores. Until they get serious about doing something with them (either closing or selling), they are doomed to play second fiddle to Netflix. They just cannot compete with Netflix on cost and people do not want to have to get in a car in January to go get a video.
Since Blockbuster was last to the online download game and still has not established themselves there, one cannot even say that there is a light at the end of the tunnel…
Blockbuster has gone from the leader in its business to a great business school case study about what happens when management does not see how its business is changing.
The sad thing for shareholders is I think Blockbuster still cannot see it.
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Bill Miller, Recession?, Bank Stocks, Rite Aid, Master’s Picks
– Can’t argue with this. Great investors do not “lose it”.
– Here is the case against a recession.
– The case for buying banks
– Rite Aid has not been on my radar screen but at these levels, deserves a look. Thanks to the Masters
– Speaking of the Master’s, here is a list of stocks they think will bounce before 2007 is done.
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How could you announce million dollar “retention” bonuses for executives and then days later announce results like this? Watching these guys operate is like watching a monkey try to impregnate a football.
For the three months ended Nov. 30, Circuit City’s (CC) losses ballooned to $207.3 million, or $1.26 per share, from $20.4 million, or 12 cents per share, a year ago. Excluding tax-related accounting items, losses totaled 64 cents per share in the latest period.
Sales slipped 3 percent to $2.96 billion from $3.06 billion a year earlier, with sales at stores open at least a year falling 5.6 percent.
CEO Phillip Schoonover still insists Circuit City is on the right track. “We’re implementing the right initiatives to lead to profitability and sustained growth,” he said. “We’re staying the course on our longer-term strategic initiatives.” By long term do you mean by the end of the decade Phil? I mean it has taken you three years to ruin the company, do you really think you can bring it back faster?
Regarding the bonus announcements, Schoonover said the bonuses are essential to keep together a team he spent three years assembling. Three years assembling a team to get these results? Far from getting bonuses for staying with CC, these incompetent buffoons ought to be thanking god everyday they are even employed.
Bruce H. Besanko, Executive Vice President and Chief Financial Officer made the following inexplicable statement regarding the bonuses:
“The base program that we have in place was a combination of stock options and restricted shares. Because of the current stock performance, that program for many of our executives was underwater and so far underwater that it didn’t have any meaningful value over time. In addition to that, our senior most executives did not receive a bonus for the last two years and will not receive a bonus based on this year’s performance. So we have two plans now to retain those leaders. One is our cash-based retention program and two is a stock-based incentive program which is in line with our annual stock-based incentive program and I feel I have the tools in place now to keep the management and leadership as well as the managers at all levels in the company engaged in this work.”
Essentially, he is saying that because the executives performance has been so bad, under the old plan, they were not eligible for a bonus. That being said, CC decided just to lower the bar, just show up for the next three years, performance be damned to get your money. This is disgusting.
This makes me want to buy shares just to bash them every single day……how can shareholders stand for this?
If that isn’t enough to have shareholders going into vapor-lock, Schoonover then said, “We are very dissatisfied with our third quarter results. We underestimated the financial impact from the disruption of our transformation work.” Here it comes “We believe that these issues are primarily self-induced”.
He “believes” they are? What else could it be? What were they doing, remodeling stores in the middle of the Christmas shopping season? Shares are down 25% today and now down 70% for the year.
Back in June when people speculated Eddie Lampert and Sears might make a run at CC, I opined, “Eddie Lampert, based on past history would just be as likely to wait for these buffoons to run it into bankruptcy and buy it there even cheaper than now.”
It just may get there next year…..
Let’s not forget that current management turned down a $20 offer per share from private equity not too long ago…. shareholders will never see that price again, not with these guys in charge.
Finally, A note to Herb Greenberg: How can you in all intellectual honesty say Eddie Lampert at Sears Holdings (SHLD) is worse than this guy? Herb, Sears IS MAKING MONEY!!!!
This is a call for Herb to do a “do over” with his pick for 2007. We’ll give him a Mulligan or should we now call it a Greenberg?
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UPGRADES
Globecomm Systems GCOM Collins Stewart Market Perform » Buy
Pier 1 Imports PIR Wedbush Morgan Hold » Buy
Knology KNOL Morgan Keegan Mkt Perform » Outperform
Itron ITRI RBC Capital Mkts Sector Perform » Outperform
Genomic Health GHDX RBC Capital Mkts Underperform » Sector Perform
Research In Motion RIMM Bear Stearns Peer Perform » Outperform
Rite Aid RAD UBS Neutral » Buy
Schering-Plough SGP Lehman Brothers Equal-weight » Overweight
IMS Health RX Robert W. Baird Underperform » Neutral
First Horizon FHN Keefe Bruyette Underperform » Mkt Perform
DOWNGRADES
Anadigics ANAD Charter Equity Mkt Perform » Mkt Underperform
Respironics RESP Caris & Company Above Average » Average
Genitope GTOP Punk, Ziegel & Co Buy » Mkt Perform
Cognos COGN Wedbush Morgan Buy » Hold
Ruby Tuesday RT KeyBanc Capital Mkts Hold » Underweight
Genitope GTOP RBC Capital Mkts Sector Perform » Underperform
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