Thursday, December 17, 2009


one of the behavioral finance ideas about mistakes people make says that most investors mindsets are skewed by recent history -- they lose perspective and will often extrapolate recent experience into the future regardless of whether that makes sense or not. Consider the VIX and Rosenberg's comments about it. In fairness to him he is an economist not an options person.

but he recently made comments about the VIX spending a lot of time next year between 30 and 40. The problem is that makes no sense unless you expect sharp declines and a huge increase in the volatility of the market -- i.e. daily up and down moves north of 2%. A VIX of 21 is very close to its lifetime average so insurance is not cheap.

historical volatility is running significantly less than implied volatility so the VIX is currently most likely overpriced by several percent in terms of what the actual volatility will be in the next 30 days. in other words to justify the current level of the VIX we need to see a sharp increase in volatility. what is even more strange is the VIX futures were recently at a 4 point premium to the cash VIX -- so the difference between the VIX futures and recent actual volatility is at least 10 percentage points. wow.

I figure as long as that volatility premium is in place or folks are talking about a VIX of 21 as saying there are cheap puts available, its bullish for the markets.

that said, I'm not sure I expect the move to 1250 by mid january that was written up in Barron's this last weekend. I've also seen the end is here type of writing -- Kass went "all in" on his short position this week -- huh? is it really that bad right now that all in short is the right posture. he did this wednesday so Thursday's decline is great but he didn't say anything about covering shorts so I assume he ended today still all in. wow.

Also read a lot of comments about consolidations or tight ranges end with the prior trend in place -- i.e. everyone expects the market to break out its just a matter of time. then Thursday's decline hit -- perhaps that changed enough minds but chances are most still believe it. yes I do too but I'm not in any hurry either --

I am starting to think we will simply widen the range up and down rather than break out. so add 25-50 points on to each end and that is what I'm thinking about (say from 1025 to 1170). that way we can stay within a range for that much longer and frustrate as many market players as possible.

Thursday, December 10, 2009

Boring like I said

I posted the market would likely be range bound or boring last time -- dec 2nd is the date stamp but I had been meaning to write that comment for at least a few days prior. looking back it turns out that the SPY has been in a $2 range from 109 to 111 since November 9th. The IWM has been between 58 and 61 since about that time. Dubai Friday is the only time the market has been outside those ranges. great time to have sold premium -- question is how long can it last? can it last through expiration? would be nice. Can it last through the end of the year? possibly. We were oversold recently but couldn't rally -- now we are overbought and can't really fall. Last note I said I thought it was more likely we have a pull back rather than a big rally -- now I'm not so sure.

The SMH getting to $27 or breaking out from the range it had been in since early August either means one or two things -- rotation continues as the energy/basic materials area has gotten whacked while tech/semi's outperformed or it means the range of the market will be resolved to the upside. We are still over bought so its likely we meander longer but I don't think we will see a decline below 1080 -- at least this year.

One reason the upside was capped is because we are hitting the half way point from the lows to the highs (roughly 666 and 1565). The QQQQ's hit that point around $40 -- late July is when the index first got to that level and it took until early-mid sep for the index to really break free of the $40 level. We first got to the 1100 area around mid oct and then had a sharp pull back to the 1025 level. We have been back around 1100 since early November. So in comparison to the QQQQs the SPX has spent about the same time -- break out could happen now if we got the momentum. I'm thinking it will be another week or so before the overbought condition is worked off but next week is expiration week -- lots of folks have sold premium and are sitting on fat profits. that means any movement outside of the range that has been in place will lead to options sellers panicking -- adding fuel to the rally. I think the highest probability is we don't break out of the range but if we do -- expect a pretty good gain.

one reason why I don't expect us to break the range? weakness in financials.

ERII -- the stock popped partly due to an upgrade from Baird and partly due to their buying one of their competitors -- someone with a similar device that works best in smaller plants. The device is lower cost and not as energy efficient but the lower cost is what matters for the smaller desalination plants. this expands ERII's market into an area that is less impacted by financing troubles. Also Pump Engineering already has a business outside of water -- they sell to nat gas processing plants. ERII has talked in the past about taking their ceramic tech and energy recovery ideas to other industries but nothing yet -- this gets them started. a big deal. water is a great place to be but if you can leverage existing tech to get into other markets that's a great growth and margin booster. I'm hoping to get long some more if it can pull back towards $6 -- so far the most it has pulled back is to $6.40 maybe. but the market hasn't had a down day either -- we'll see.

Wednesday, December 2, 2009


Do you remember the beginning of Jaws the movie? The woman is swimming in the water out to the bouy at night and suddenly her head gets jerked under water but she pops back up quickly wondering what had happened. eventually she is eaten and one of the great movies begins. Was Dubai the first head jerk and the market is about to get eaten with a big decline as everyone realizes there is a massive world wide commercial real estate collapse coming?

The only thing that makes me concerned is a sharp jump in CDS spreads for various countries including the US and some emerging markets I believe -- I'm getting this second hand so I'm not sure how accurate the info is. Rising CDS spreads is not good -- may suggest a more significant pullback is coming.

my own thought on commercial real estate has been that there is too much money waiting in vulture mode -- prices won't get to where many are hoping and assets will get dealt with as new capital is put to work. many in real estate would say that is a ridiculously optimistic and naive view. Probably true but my thought is it won't be as bad as the bears think.

have you seen the semi's? they are rallying again but so far just to the top of the range. At some point they are going to break out because its not double ordering. CY has certainly done well.

in the near term I expect the market to be boring as can be -- although if I had to pick a direction it would likely be lower -- internals aren't too good and sentiment is more bullish than it has been in awhile -- not enough in my mind to signal the end of the rally but enough to see a pull back. on the other hand if you see what happened last week -- Dubai -- at most about a 3-4% drop in the SPX led to about a 30% jump in the VIX --- so people buying puts like crazy on a small decline. I figure the weak internals and bullish sentiment and the fact that we are still near the half way mark between the lows of march and the highs of 2007 means the upside is capped for now. The rush to puts on any decline means the downside is likely capped too -- at least for the moment.

a few other stocks I am monitoring -- BLUD -- after we sold this one they ran into FDA and DOJ troubles and the stock got crushed into the teens. business still doing ok. story hasn't changed -- the secular story is the switch from manual to automated testing. its not a great secular story in the sense that unit volumes for the industry aren't growing a lot but the valuation is attractive for the quality of the business and the consistency of the blood transfusions.

LMNX -- sells testing equipment used for proteins and nucleic acids -- they have a deal with Techne actually. their system handles multiplexing -- running multiple tests on multiple samples. ILMN has a competing platform called bead express but the key to LMNX is the installed base -- about 6000 units vs. only a few hundred for ILMN. That's a lot of systems to drive consummable sales. the growth story is about getting as many tests approved on the system as possible to drive usage and more system sales. their system has particular advantages in certain types of tests -- that's what you do leverage your strengths. they have missed earnings the last few quarters but its primarily a function of their model -- they have little visibility into what partners are doing with consummables so its not surprising that they struggle to give guidance they can beat -- their fate on a short term basis is in someone else's hands. TSRA fixes this problem by reporting revenues 1 quarter in arears -- something LMNX should think about. the other issue is they have not seen as much operating leverage as everyone wants. to me its in the stock given how poorly the stock has performed. remember there are 2 kinds of companies -- those with problems and those with problems everyone knows about.

CVA -- while the hoax of global warming is finally coming out (I can't think of a more complex system then our climate -- one which we have very little accurate data on relative to the total set of data (millions of years) it is the ultimate in human arrogance to assume we know anything about our impact on temperature), I still think there is potential for certain alternatives like Covanta, which is actually 2 businesses in one -- waste management services and power generation (incinerator for garbage). europe is a much bigger user of waste generated electricity so we have a lot of catching up to do. CVA has ops overseas too but I suspect they have more opportunity in the US given the low penetration. Its profitable, and the valuation on a cash flow basis seems reasonable. they do have a lot of debt which is worrisome -- initial answer is they also have a lot of cash flow so its manageable but I want to do some more digging. the chairman is Sam Zell and one of the largest owners is that marty guy from third avenue value -- noted deep value investor. is this a deep value? only based on growth projections but I think its still attractive. On earnings basis its nearly 20x so it doesn't look good relative to something like Waste Management that is much cheaper or even MCD -- which is low teens for such a franchise company with a 3.5% yield. need to do more valuation work. i like them better than Waste management -- don't trust the numbers there and the electricity side is very small. I am a big believer in the growth of electricity demand.

Tuesday, November 17, 2009

more stock comments

UEPS -- got the chance to read some street research from Baird on the quarter. I was shocked to see the discrepancy between what UEPS is paid in South for welfare payments and what they are paid in Iraq for various government payments like war casualties, etc. UEPS gets about $3.7 in revenue per card per month in south africa. In Iraq they get about 22 cents -- are the services that much different? don't know. if they got the same in SA that they get in Iraq, revenues would be a lot less. I checked back to the reports I could find from the past and a year ago the same analyst was talking about IRAQ earning 70-80 cents in revenues per card per month. that's better but still not close to SA levels. I can remember reading previous notes from this analyst that assumed growth opportunities like Nigeria and wage payment in south africa would reach $2 in operating profit per card per month at maturity similar to South African welfare. I thought he said the same for Iraq -- turns out it was .50 in operating profit per card per month. still have a long way to go to reach those levels.

Do I think the $3.7 they get from SA is too high? of course. Is it likely to change soon? no because they have the contract, they are one of the few if not only people that can operate offline in the rural areas of SA, while still providing broad smart card services.

CEO just announced he is selling half of his shares over time. that's not a positive sign although its not necessarily negative either -- it means he doesn't think the stock is about to materially jump but it doesn't mean he thinks its going to fall any time soon.

There is no doubt that UEPS is an incredibly cheap stock for the metrics they can produce now -- issue is how sustainable are those metrics like high free cash flow and high return on assets? how quickly can they diversify their business away from SA welfare and or can they earn similar economics elsewhere that they earn in SA? I have said before that until UEPS gains traction in a 2nd area such as Nigeria, Iraq, Ghana, wage payment, etc. the stock's multiple will suffer. To me its limited downside and lots of upside potential thanks to the cheap multiple.

Wow - I guess someone was really hot to trot to sell Cypress Semi and once it hit the 200 day moving average the selling has dried up -- stock was back to almost 10 after being near $8 not that long ago. I am recouping losses on that one but I didn't get the chance to ramp it up near $8. Still like the secular story here plus the cyclical one that if ECRI is right and the recovery exceeds expectations then all this nonsense about double ordering on the semi' side will give way to outperforming growth.

I still hope to cover a few others such as MXWL, etc. but not tonight.

Wednesday, November 11, 2009

a few stock updates

I am slowly working through conference calls and other earnings related info to get a handle on my stocks. As far as the market goes -- we have rallied to the highs and the big question is will we sell off again to retest the last low or will we keep climbing the wall of worry. My first thought has been the trading range (1025-1100) would continue for awhile longer but I am wondering if too many other folks are not expecting new highs. Various sentiment measures reached similar extremes as in mid July.

Lots of big money boys have sold calls and bought puts trying to protect gains for the year -- if we do rally, then many of those folks will panic and buy back the calls, which will force the market higher. That would seem to be a likely scenario given that it would cause the most pain. I know I am short calls so a big rally would cause my stocks to gain but my options to lose -- so I'm a bit hedged as well. Only 7 trading days to expiration....

Some stock comments:

Iridium -- I went and saw Whitney Tilson of T2 partners make a presentation and this is their largest holding. I know they own warrants but they also probably own the stock too. The 30 second version: Iridium is the only reliable way to gain global communications coverage for those that need it. Terrestrial coverage is only 10% of the earth's surface area so shippers/logistics, military, those that sell products everywhere (Coca-Cola?), etc have no other choice. Their biggest growth is from machine to machine communications -- still working on some examples of that. Anyway, if you want to play the story, make sure you buy the warrants rather than the stock. to me the warrants are undervalued and offer much greater upside potential.

Warrants exercise at $7 (IRDMW) and expire in Feb of 2013 so with the stock around $9.50 to $9.70 you have about $2.6 or so of intrinsic value and only about $1.1 of time value despite more than 3 years of time to expiration and an IV for their longest options of like 50-60%. A back of the envelope (i.e. not 100% accurate but close enough for me) model for the warrants suggests that at $3.70ish they have IV of 25-30% or well below what I would expect given that its a small cap stock and the IV for their options is 2x that level. Now, keep in mind that the warrants will be FAR more volatile than the stock -- a drop in the stock would crush the warrants so base your position size on the stock's value not on the warrant's. To really take advantage of the low IV in the warrants, you should probably delta hedge -- i.e. short some of the stock to reduce risk in case of a drop. They report earnings thursday.

ILMN -- stock bottomed near $32 same as after the June quarter. There were a few issues with the quarter as to why they disappointed. From what I understand they have a quality issue that forced them to remove product and that hurt sales. There is also delays in stimulus and a lack of projects for the genome wide arrays. These seem like short term issues to me but the longer term risk is if the quality issue leads customers to diversify away from ILMN whose market share is quite high due to their lead and strong previous track record of quality product. To me they are still leaders in one of the key areas of health care technology -- DNA analysis. I will look to sell out of the money puts to take advantage of the pull back to add exposure.

TSRA -- I think the value has to be clipped some for the DRAM business being smaller than first thought due to the volume deals but the stock more than reflects it -- they have about $9 a share in cash and an optics business worth a similar amount so you are getting a microelectronics business that generates more than $1 per year in free cash flow for about $5-6. Either that or you put the value on microelectronics and get the optics for free. its a cheap stock. They have better financials then other royalty companies and yet have a lower valuation -- over time I believe this will be resolved positively. Within a couple of years I would expect them to produce free cash flow of $2 to $3 and that should drive a stock anywhere from $40 to $60 -- well above where we are now. That presupposes they will be able to renew their major license contracts that expire in 2012 at similar terms -- new technologies like micro pilar should make this a non-issue -- the customers will renew because TSRA offer's a better solution than they could develop on their own.

ARCC -- They spent the last several months doing due diligence on ALD's portfolio before deciding to buy them for .5x book value. There is huge opportunity here for ARCC in a scavenger role. ALD has already reduced the value of their assets by probably half so to pay half book value is a further margin of safety. So there is the upside that comes from potentially paying less than the assets are worth. There is the upside from lowering ALD's funding costs, which are well above ARCC's. There is the upside from shifting ALD's portfolio into more debt and less equity to boost risk adjusted returns and generate higher income. The deal is immediately accretive and should materially increase ARCC's value over the next couple of years. What is material? I wonder why they won't be able to increase dividends to north of $2 over the next couple of years. That's about 50% higher. I think this could be a high teens stock paying a double digit yield. -- vs. $11 bucks now? still lots of opportunity despite the rally from under $4 in march. That was a ridiculous price that had no bearing on value -- it was forced selling related.

UEPS -- haven't had the chance to review the call yet but numbers all looked good. In FY09 they produced over $100 mill in free cash flow on a revenue base of $250 mill and assets of about $500 mill -- that's not bad. They bought back almost 20% of the stock last year (took out a large private equity owner) so the assets are now closer to $400 mill but the cash flow is growing. Close to 25% free cash flow return on assets. The stock has a market cap of just over $1 bill -- about 10% free cash flow yield. so over 40% free cash flow margin with great returns on assets and huge growth potential in terms of getting more smart cards in new countries -- Iraq, Russia, rest of Africa, etc. and yet the stock is super cheap. essentially everyone believes they are going to lose the SA welfare business (at least the economics so keep the deal at lower pricing) and not pick up business anywhere else in the world as an offset. My bet is that they won't lose SA and they will gain SA wage payment, Nigeria, Ghana, Iraq, Russia, etc. so that in a few years they are producing $4-5 in free cash flow (instead of the $2 now. With a more appropriate multiple, I reiterate this could be a $100 stock in a few years. in the meantime they were able to buy back 16% of the stock last quarter and still have cash at the end the quarter at about 1/3 of assets with no debt. They are a cash machine it is only a matter of time before it becomes more known. I am thinking about writing up a full discussion and submitting it to we'll see.

Friday, October 30, 2009

that was quick plus what $300 could have bought

I didn't realize how right I was about a bounce and more downside -- too bad I was out yesterday and didn't get the chance to sell or buy puts or anything -- just let it all ride. ugh!

With the VIX having gone above 31 now the big question I have is about breadth -- is it worse today then wednesday given that we are at lower lows on the S&P 500? I don't have the numbers for wednesday so I don't know for sure but like I said the other day -- small caps hold the answer. if breadth has improved then that would be a positive, which along with the high VIX and the oversold nature of the market should get us a better bounce -- one that lasts longer than a day. if breadth made a lower low today like the market did, that just means we have risk of further downside even if we get a decent bounce. check out the QQQQ's -- now near their early october lows -- say those hold and the market rallies towards 43 but doesn't get further and then pulls back -- that will look like a H&S top forming. just like in July in the SPX. For the same pattern in SPX we may need to fall off to 1025ish -- the oct lows and then rally up to 1080ish.

on to stocks. TSRA -- well we didn't quite get the positive report we were hoping for -- great Q3 but Q4 guidance sucked to put it bluntly. Everyone following the company closely understands they have volume deals with a couple of DRAM players -- that doesn't mean we always remember that in thinking about guidance expectations nor that we understand just how big of a deal it can be..... so they are explaining a 10% sequential decline in their main business because of these DRAM deals (above certain volume thresholds their payments from 2 customers either end or drastically fall off). wow. My first thought is have to keep in mind that their revenues from DRAM can only be so big in Q4 and Q1 due to these deals regardless of how good the market is.

Second thought -- they need to diversify away from being so tied to DRAM -- that was the plan with the wireless court victory but so far it didn't quite work out as expected as the defendants are appealing rather than settling like prior losers had done. Still like the story but its longer term -- optics still building and the cooling tech looks awesome but its 2-3 years from now at best. I had the right idea of wanting to sell at $30 with the covered calls -- unfortunately unless you also buy puts to protect your downside, selling calls doesn't actually get the stock sold at that level unless you reach expiration above the strike. a lesson learned.

I had actually sold puts (25 strike) if you remember back a few weeks -- I bought them back luckily for 30 cents when the stock was near $30. That's the $300 -- what can it buy? 10 of the 25 strike puts on that day a week or so ago -- they are now worth close to $3500. a lesson learned.

so in that case hedging costs for the big drop were only 1% -- granted you had to experience the $30 to 25 decline first but even then the puts would be rising in value on a trading basis. point being I need to start hedging more -- its insurance. and just like most insurance you should expect it to cost money most of the time. you insure your house, life, auto, etc. but I have heard stories of wealthy folk (i.e. not me) who insure their 10 mill home and cars and life, etc. but refuse to buy puts on their 100 mill portfolio because they are too expensive. ok, dump the insurance on everything else and buy the puts on the portfolio.

AB also reported results -- much better than expected -- still seeing outflows but results are improving. need to do some more on this -- what can I say its a firehose of info in earnings season not to mention me trying to find employment -- but the key issue for me on the quarter was how sustainable that 67 cents was -- there was some investment gains and obviously the level of the market matters but if we are at least flat market wise can they earn 67 cents going forward? if so that's about 2.70 or about 10X earnings. i'm guessing that its somewhere between that number and the 1.6 that was the estimate prior to the report

Thursday, October 29, 2009

bounce then more down

My assumption is we bounce and then see the downside momentum return -- if we manage to see improved breadth on the next decline that would be a positive sign that momentum was returning. when the large caps start meaningfully outperforming, that's generally the last leg of a rally -- it can last quite a while but we are hoping the small caps come back ...

Small caps (Russell 2000) look like a double top -- around 62.50 and then breaking below the valley in the middle (57.50) yesterday to close under 57 -- doesn't seem good. one reason I expect further tries at the downside. Another is too many I read seem to be willing to put money to work -- people finally assuming this is just another brief pull back -- that means its probably not since in the past I wasn't reading about people wanting to put money to work but rather of the bears gloating. there has been some gloating but not as much.

by the way, have you noticed how we have bottomed in the early days of the month lately -- it was about a week or so into the month in July but first couple of days in early sep and oct. not sure why this has happened -- typically you would expect strength around the end and early month due to what people call mark ups at the end of the month and 401k cash being put to work in the early part of the month. interesting. so if we bottom earlier this time, perhaps I'm not the only one that has spotted this.

how far do we bounce? watch the puts and the VIX -- the slower the VIX is in dropping or the more puts people keep buying during the bounce the higher and longer we go. if those two turn quickly, then the bounce is unlikely to last long. what is quickly is a judgment call.

TSRA reports tonight -- I feared they would disappoint the elevated expectations when the stock was in the low 30's but now that we are near $25 we should get some help from a positive report.

UEPS is another one that has surprised me in how far it has declined. of course it surprised me how high it rallied too. the stock is still too cheap but to really get this thing moving we need to see them get scale in another business besides south african welfare. whether its russia, ghana, nigeria, iraq, south african wage payment, etc, one of these sizable growth areas has to reach that point where the network effects kick in and creates a business with very strong dominance -- i.e. where so many use the cards and so many accept them that it is difficult to imagine life without UEPS -- that's the way welfare is in SA. once that happens it will diversify them away from SA welfare and drive the PE up dramatically. their returns and cash flow are so strong they should be selling at a big premium. the fact that they are not is due to their inability to get past welfare in SA (in my humble opinion). since welfare is a contract that can be changed at the governments whim, they need another area of scale to convince people its not temporary. I have consistently believed they would do it but it sure takes time and patience.

oh -- did I cover ARCC yet? can't remember for sure. not much to say yet because they haven't put up the presentation or reported Q3 but the merger with Allied Capital is a big deal. if well executed, this could materially improve the value -- like closer to $20. The key is how bad is ALD's book of loans -- I considered ALD to be amongst the worst BDC so I'm glad ARCC is only paying .5 times book value but that assumes ALD only valued their assets at 2x reality. It could easily be 3x or 4x which would create losses for ARCC. I have confidence in ARCC's ability to do due diligence -- presuming they got the chance to look these loans over good, then I would feel better -- hoping they cover that in more detail on the call next week. The other key is how quickly ARCC can lower ALD's funding costs -- which are well above ARCC's. The addition of ARCC -- i.e. the combination of the two should be able to lower costs and improve performance going forward -- i.e. with ARCC picking new loans they should perform better in the future. ARCC should be able to lower funding costs the question is how quickly. while it would be best to wait for further info on the call, the stock could drop further before then due to the uncertainty. you get the best price stepping into the uncertainty. now if it doesn't pull back more, it gets harder -- expectations higher.