Bear Stearns and all else

Bear Stearns shows what happens when you are pushing the envelope on leverage during a financial crisis -- they had too much kindling around and a spark hit them last week. By Thursday they needed to be bailed out this weekend the talk is a $2 buyout. wow. if Bear Stearns is worth $2 then what is DFR worth? how about LEH? MER? etc. I expect a sharp downward drop on Monday at least for the financials followed by hopefully a recovery at some point.

First reaction is everything is worthless if Bear is only worth $2.

Second reaction is if Bear is gone that could be the failure that signals a bottom is at hand. The system survived, etc. most others weren't as leveraged or as vulnerable -- bear was too tied to fixed income especially mortgages and that is why they were more vulnerable.

DFR -- almost not a REIT -- they are down to only $500 mill as of last Monday but they are still just doing the minimum to survive. another week later and I'm guessing they have sold more of the portfolio and lost more money. why they couldn't sell the non-agency mortgages last fall or unwound the interest rate hedges sooner is beyond me. could have saved us all a lot of money. big question remains what is the money management business worth.

Great businesses -- Buffett has some commentary in his latest report about what makes a great business -- See's candies increases their pretax income from $5 mill to $82 mill yet their capital is only up from $8 mill to $40 mill. So a $77 mill increase in income from a $32 mill increase in capital -- that's pretty good returns. Not to mention See's has had free cash flow of about $1.5 billion since the early 1970's when Buffett bought it.

My strong business' -- MCO, TECH, FDS, UEPS for starters. They each require little capital to operate and have been able to maintain high returns on capital while growing the capital base.

Moody's has $1.7 bill in assets as of Dec 31st up from $300 mill in 1998 (I think these numbers are right -- I'll fix them tomorrow night if necessary). FCF is up from under $100 mill to over $700 mill in 2007. maintaining high returns as capital grows.

Looking forward -- the biggest risk remains the growth in debt -- likely that debt outstanding shrinks by 10-20% over the next few years. I was looking at their recent preannouncement and thinking about the numbers again. Current estimates are $1.8 bill at worst -- closer to $1.9 bill in revenues would be consensus. I think reality is closer to $1.7 bill at best. That assumes structured and asset backed drop 80% off of 2007 levels. Hopefully that still isn't too optimistic. Assuming 40% operating margins with a 40% tax rate -- think $1.60 in earnings -- so the stock is at 20X 2008 estimates -- a little high but that would definitely be depressed earnings. I could see 2009 being closer to $1.85 bill in revenues or over $2 in EPS. At that point the stock should be in the high $30's to low $40's. a nice gain from here. Could it see the mid 20's? sure but at that point it would be cheap enough for Buffett to buy more. Analytics could be close to 30% of revenues in 2008 -- international could be close to 50% of revenues. My guess would be US ratings would be down to less than a third of revenues. That would be impressive.

FDS -- reports on Tuesday -- will surprise all those selling the stock pre-report. look for a sharp short covering pop because they will meet numbers and not lower guidance. Too many hedge funds assume that FDS must have to cut and miss yet they don't understand that most of the business is buy siders not hedge funds or fixed income. equity buysiders cruising along -- some pressure but not really.

Looked at ECL this summer -- not as good a biz as FDS and MCO but good growth. 30% of ECL is for sale -- Henckel. That could drive the stock below $40 if the market has trouble absorbing all that supply. Lots of growth opportunity at ECL. will need to keep an eye on that one -- nice steady grower with international and health care plus industrial opportunities at a reasonable multiple.

some say their are 2 markets but I think its more like 3. first are the financials -- ugly. second are the consumer stocks and other US economy based companies that are hurt by exposure to financials or the consumer. Last are the stocks tied to commodities, international demand for most anything but especially for infrastructure. the 3rd group looks expensive but keeps on chugging. 2nd group -- many cheap stocks but don't know where the bottom is. 1st group -- who knows which ones survive.

others in 3rd group besides the energy ones I have talked about -- PX or APD -- gas companies. DNA type life sciences like ILMN and TECH.

after being 9% better than the market last year I am behind by 4% in 2008 so far. DFR and TSRA have been problems. CME has fallen more than I expected too -- given that its a monopoly. With any luck TSRA will win the arbitration and the appeal of the ITC ruling. That would get the stock up about 10 points from here -- my guess.

Been looking at GPRO too lately -- they are a testing company selling tests for STDs plus screening the blood supply for various things like hiv, hbv and hpv. they are down to only 26x earnings but that just doesn't seem cheap enough for me. I would rather buy more FLIR or maybe even more BLUD. Still thinking about that deal. Don't know enough about bioarrays to know for sure whether this is going to be a great deal or not.

enough for tonight. here's to hoping the reaction to bear isn't as bad as it could be -- down 5-10% across the board for financials is my base case with some down 50% or more (think lehman).