Thumb sucking again! what is this the 2nd or 3rd time I have whined about thumb sucking and missing a chance to add to TECH? ugh! Anyway, over the last week or so I have thought about adding to TECH because the stock had dropped a good 10% or so down to $60 and below. I was planning on swapping my MDT for it -- of course that one has dropped too but the difference is TECH's fundamentals are strong while MDT's are questionable -- could be improving but have consistently been worse for awhile.
I couldn't get past the idea that TECH's multiple was several points higher than MDT for what should be about the same level of growth. So what happens? Techne reports a stellar quarter -- just blows away the revenue and earnings estimates. So the stock pops over 7%. Meanwhile I reminded myself that the PE premium that TECH has is due to 2 reasons 1. much better profitability and 2. much higher confidence in that growth rate.
TECH is a better business and therefore deserves to trade at a premium to MDT. That said, MDT is a turnaround story -- one that could show improving fundamentals in which case it could turn out to be the better stock after all. TECH hasn't actually been the best of stocks -- I have owned it for about 18 months and my gain is about $10 a share or a high teens percentage. That's not bad -- its in line with what you would expect -- a slow consistent rise upward that after several years will look pretty cool but at any one time looks pedestrian. Not a bad idea to have a few of these lower beta (less volatile) stocks in the portfolio to balance out those gazelles.
Have to wait and see -- may get another chance to buy in and hopefully this time I won't miss it.
Wednesday, January 30, 2008
Monday, January 28, 2008
CME and GOOG
CME is now in talks to merge with NYMEX. They already have a clearing/operations deal with them for trading some energy contracts so the two companies are very familiar with eachother. I would expect some cost synergies but more importantly would be the ability to move the Nymex volume to Globex (CME's electronic trading platform), which would have a positive impact on volume and therefore earnings.
The stock was down to flat today despite the strong up move in the market. The stock is trading around 30x, which I think is not a bad price for the quality of the business and the growth potential of the company.
financials and consumer discretionary stocks definitely making a comeback over the last week or so. I remember making various comments about how financials had bottomed and would bounce but I admit my timing wasn't the greatest. Google is my current enigma -- I expect their earnings to be pretty good yet the stock has dropped like a stone. Granted, the stock's rise from $500 in the summer to $700 at the peak was a very steep rise and makes the decline seem bigger than it really is. What I mean is that Google is still up 10% or more from where it was in July -- it might be down 20% from September/October but its still up from July.
Should I have taken profits in Google while it was near $700 -- absolutely. Is the stock vulnerable to further declines from here? unlikely. Not unless fundamentals are weakening. VMWare's miss after the close could be a sign that tech demand is weaker than anticipated. Of course VMWare is up against MSFT so that might have more to do with it than a general slowdown in tech spending.
Google's main problem is the same as Apple's problem: Cramer. The mad man boosted their stocks for so long that now they are in a hangover -- the stocks became too over owned and too loved by too many funds and too many individual investors. Now those investors need to raise cash and that means selling Google and Apple regardless of what happens with the numbers. As this selling is completed the two stocks will be at very attractive levels but its hard to say how long that adjustment takes.
The stock was down to flat today despite the strong up move in the market. The stock is trading around 30x, which I think is not a bad price for the quality of the business and the growth potential of the company.
financials and consumer discretionary stocks definitely making a comeback over the last week or so. I remember making various comments about how financials had bottomed and would bounce but I admit my timing wasn't the greatest. Google is my current enigma -- I expect their earnings to be pretty good yet the stock has dropped like a stone. Granted, the stock's rise from $500 in the summer to $700 at the peak was a very steep rise and makes the decline seem bigger than it really is. What I mean is that Google is still up 10% or more from where it was in July -- it might be down 20% from September/October but its still up from July.
Should I have taken profits in Google while it was near $700 -- absolutely. Is the stock vulnerable to further declines from here? unlikely. Not unless fundamentals are weakening. VMWare's miss after the close could be a sign that tech demand is weaker than anticipated. Of course VMWare is up against MSFT so that might have more to do with it than a general slowdown in tech spending.
Google's main problem is the same as Apple's problem: Cramer. The mad man boosted their stocks for so long that now they are in a hangover -- the stocks became too over owned and too loved by too many funds and too many individual investors. Now those investors need to raise cash and that means selling Google and Apple regardless of what happens with the numbers. As this selling is completed the two stocks will be at very attractive levels but its hard to say how long that adjustment takes.
Thursday, January 24, 2008
nothing like a little volatility
The portfolio has lost about 200bps of relative performance to the S&P 500 the last 3 days -- that sucks. To some extent I'm giving back some of the great performance I got from being long asia, energy and not owning financials over the last few months. This week financials have been rallying while my stocks have been pulling back. In some ways its just the way corrections work -- the problems go down hard and fast but eventually bottom. The good stuff (hopefully in my case) goes down late and not as much but comes back too. Imagine a fund manager realizing all his financials are down 30-50% but his Google is still up huge since July -- why wouldn't he trim the winner while its still up. That gets the ball rolling and then the momentum types bail and then the oh my goodness chartists sell because they violated some rule.
I say all that but the reality is that corrections serve to change market leadership while everyone is distracted by losses. I am talking about leadership for the next few months not long term -- in the next few months I would expect consumer discretionary (retail, restaurants, etc) and financials to do better than the market while energy, tech and other areas may struggle. Its all hard to say for sure but it could happen. I would bet that after a bounce back the financials will roll over again to go back to their lows but that kind of depends on where we are in recognizing losses, where the fed cuts to and other stuff.
Interesting comments I have seen from others -- Fed is trying to prevent a repeat of the great depression but in doing so they are driving us towards the Japan scenario or a repeat of the 1970's depending on how successful the Fed is at reflating the economy. high energy prices, the promise from the dem's of higher taxes and a fed cutting aggressively look like the 1970's but all of our debt makes us look like Japan -- our low rates due too. such great choices we face. that's why asia may suck for a time due to things getting ahead of themselves but over longer time periods that's a great place to be.
By the way, 12:53pm wednesday and Cramer says here we are at the lows again and he says they hold and its time to buy. I bought some more CLB yesterday but just a nibble. What I realized afterward was that was the chance to buy some calls on the S&P 500 -- I checked out the feb 1325's and they traded between 18 and 47 yesterday closing at 47. Assuming the 18 was near the lows of the day -- that would have been one profitable trade. Buy 10 calls for less than 2000 and sell them for 4500+ all in a couple of hours work? good deal. everytime Cramer makes a call like that I think about it but usually don't or can't (work).
AB had reasonable numbers -- I think they are well positioned but it will take some time for the hedge fund performance fees to come back. in the meantime I would expect them to earn around $4 to $5 this year depending on where we end up in terms of the market. In my mind the stock is still cheap even at $4.
got to go to work
I say all that but the reality is that corrections serve to change market leadership while everyone is distracted by losses. I am talking about leadership for the next few months not long term -- in the next few months I would expect consumer discretionary (retail, restaurants, etc) and financials to do better than the market while energy, tech and other areas may struggle. Its all hard to say for sure but it could happen. I would bet that after a bounce back the financials will roll over again to go back to their lows but that kind of depends on where we are in recognizing losses, where the fed cuts to and other stuff.
Interesting comments I have seen from others -- Fed is trying to prevent a repeat of the great depression but in doing so they are driving us towards the Japan scenario or a repeat of the 1970's depending on how successful the Fed is at reflating the economy. high energy prices, the promise from the dem's of higher taxes and a fed cutting aggressively look like the 1970's but all of our debt makes us look like Japan -- our low rates due too. such great choices we face. that's why asia may suck for a time due to things getting ahead of themselves but over longer time periods that's a great place to be.
By the way, 12:53pm wednesday and Cramer says here we are at the lows again and he says they hold and its time to buy. I bought some more CLB yesterday but just a nibble. What I realized afterward was that was the chance to buy some calls on the S&P 500 -- I checked out the feb 1325's and they traded between 18 and 47 yesterday closing at 47. Assuming the 18 was near the lows of the day -- that would have been one profitable trade. Buy 10 calls for less than 2000 and sell them for 4500+ all in a couple of hours work? good deal. everytime Cramer makes a call like that I think about it but usually don't or can't (work).
AB had reasonable numbers -- I think they are well positioned but it will take some time for the hedge fund performance fees to come back. in the meantime I would expect them to earn around $4 to $5 this year depending on where we end up in terms of the market. In my mind the stock is still cheap even at $4.
got to go to work
Wednesday, January 23, 2008
more fun
Well that was fun! My Asian funds got crushed! I did mention there was room to sell them a few days ago but I never managed to pull it off.
Bernanke -- tough position he is in -- wants to tough it out but politics getting in the way. It definitely looks like amateur hour over at the fed but its really not his fault. Greenspan's willingness to always hand out liquidity in times of need has caused our market to shift from one bubble to the next. Except that it could be tough to get another bubble started given all the losses in financials. Think about it though -- one moment its so close to the regular meeting why cut in between meetings. Then he cuts anyway? looks like its totally a response to the markets collapsing so it makes him look like he is reacting rather than being proactive.
Fascinating article today on real money by howard Simons -- he claims the dollar has already been in a dollar carry trade like position since the tech bubble burst -- basically acting very similar to the way the Japanese carry trade is used to borrow yen to buy other assets. So if you borrow dollars and then invest in euro denominated assets you have made money the last several years. He argues basically that saying we are like Japan isn't going too far out on a limb because we have been like Japan for the last several years. He argues that since either 99 or 00 the two worst markets in the world have been the US and the Japanese stock market -- the rest of the MSCI World index has beaten the pants off the US.
That's why I might be losing on my Asian funds today but over the next several years the international markets will win vs. the US. Asia should be a big winner from the fed cutting -- doesn't save the financials but it will help the emerging markets perform better.
AB reports wednesday night -- most interesting question is about 2008 guidance. Will they bother to make a guess or will they say its just too hard? What will they say about their hedge fund performance fees -- maybe or no chance? I expect 08 guidance to be around $4.25 to $4.75 but that could prove optimistic if the markets keep dropping.
not sure why TECH got hit so bad today. Could be the sharp decline in WAT stock -- another life sciences stock. I don't know the specific issues surrounding WAT's drop other than 08 guidance was less than expected. I thought about selling some MDT today to buy some more TECH but decided against it. Its several multiple points higher for similar growth. Then again, MDT has been seeing estimate cuts while TECH has been increasing numbers. probably best to wait for the 50's on TECH.
Bernanke -- tough position he is in -- wants to tough it out but politics getting in the way. It definitely looks like amateur hour over at the fed but its really not his fault. Greenspan's willingness to always hand out liquidity in times of need has caused our market to shift from one bubble to the next. Except that it could be tough to get another bubble started given all the losses in financials. Think about it though -- one moment its so close to the regular meeting why cut in between meetings. Then he cuts anyway? looks like its totally a response to the markets collapsing so it makes him look like he is reacting rather than being proactive.
Fascinating article today on real money by howard Simons -- he claims the dollar has already been in a dollar carry trade like position since the tech bubble burst -- basically acting very similar to the way the Japanese carry trade is used to borrow yen to buy other assets. So if you borrow dollars and then invest in euro denominated assets you have made money the last several years. He argues basically that saying we are like Japan isn't going too far out on a limb because we have been like Japan for the last several years. He argues that since either 99 or 00 the two worst markets in the world have been the US and the Japanese stock market -- the rest of the MSCI World index has beaten the pants off the US.
That's why I might be losing on my Asian funds today but over the next several years the international markets will win vs. the US. Asia should be a big winner from the fed cutting -- doesn't save the financials but it will help the emerging markets perform better.
AB reports wednesday night -- most interesting question is about 2008 guidance. Will they bother to make a guess or will they say its just too hard? What will they say about their hedge fund performance fees -- maybe or no chance? I expect 08 guidance to be around $4.25 to $4.75 but that could prove optimistic if the markets keep dropping.
not sure why TECH got hit so bad today. Could be the sharp decline in WAT stock -- another life sciences stock. I don't know the specific issues surrounding WAT's drop other than 08 guidance was less than expected. I thought about selling some MDT today to buy some more TECH but decided against it. Its several multiple points higher for similar growth. Then again, MDT has been seeing estimate cuts while TECH has been increasing numbers. probably best to wait for the 50's on TECH.
Friday, January 18, 2008
stimulus plans
Temporary plans are not helpful because they don't change behavior and they don't do what is truly necessary right now: support and increase incomes.
Asset bubbles like we have had (i.e. soaring asset values supported by rising levels of leverage) always end in a deflationary spiral (unless the fed chairman is Alan Greenspan, in which case they just engineer a new asset bubble and push the inevitable issues out further into the future).
So what does that mean -- deflationary spiral? It means that asset prices deflate or decline and as they do they pull everything else down with them. Businesses use asset values (whether we mean financial assets or manufacturing assets or human capital assets) to generate income, which they can use to pay dividends, buyback stock, make acquisitions, pay down debt, etc. Households provide labor for businesses and often own a large asset in the form of a home. Household income and the value of the house supports the mortgage used to purchase the home. As asset values drop -- businesses earn less income and that means layoffs, which means consumers will have lower incomes and have less to spend. Lower income makes debt service more difficult. Falling house prices makes it more likely the household can't service their debts -- either through income or through the value of the home. that increases foreclosures, which pressures asset prices even more. Bottom line is that the dramatic fall off in incomes is one of the main reasons the Great Depression was so bad.
Handing out $250 checks is nice -- and predictable in an election year -- but its a one time thing that has no impact on the economy's ability to generate incomes and service its huge leverage.
hopefully someone will come up with the brilliant idea to lower tax rates -- even more than the bush tax cuts. lower tax rates help sustain and increase incomes.
with the democrats assuming they are coming to power in a big way later this year, probably nothing happens on this front this year.
Asset bubbles like we have had (i.e. soaring asset values supported by rising levels of leverage) always end in a deflationary spiral (unless the fed chairman is Alan Greenspan, in which case they just engineer a new asset bubble and push the inevitable issues out further into the future).
So what does that mean -- deflationary spiral? It means that asset prices deflate or decline and as they do they pull everything else down with them. Businesses use asset values (whether we mean financial assets or manufacturing assets or human capital assets) to generate income, which they can use to pay dividends, buyback stock, make acquisitions, pay down debt, etc. Households provide labor for businesses and often own a large asset in the form of a home. Household income and the value of the house supports the mortgage used to purchase the home. As asset values drop -- businesses earn less income and that means layoffs, which means consumers will have lower incomes and have less to spend. Lower income makes debt service more difficult. Falling house prices makes it more likely the household can't service their debts -- either through income or through the value of the home. that increases foreclosures, which pressures asset prices even more. Bottom line is that the dramatic fall off in incomes is one of the main reasons the Great Depression was so bad.
Handing out $250 checks is nice -- and predictable in an election year -- but its a one time thing that has no impact on the economy's ability to generate incomes and service its huge leverage.
hopefully someone will come up with the brilliant idea to lower tax rates -- even more than the bush tax cuts. lower tax rates help sustain and increase incomes.
with the democrats assuming they are coming to power in a big way later this year, probably nothing happens on this front this year.
market
Quite the decline since October -- from 1550 to around 1330 or so with many many stocks down much further. I remember talking in the summer about the real risk is permanent loss of capital. Yes it would be nice to have gone to cash over the last few months and I know many smart folks that have done that -- one year I will do it too -- once I allow myself to follow my instincts rather than my emotional ties to greed. that can be one expensive deadly sin.
Have I lost any permanent capital in DFR? perhaps but I'm not giving up yet. They still seem to be a viable business to me and one that is very cheap. They are smart fellows and they have a good plan. I have far more faith in the value of their assets than in any of the banks or brokers because their track record is very impressive.
Have I lost permanent capital in any of the other holdings? definitely don't think so -- AB is a high beta stock that goes up AND down faster than the market. As long as they have positive cash flows over time and are able to maintain margins and the global equity markets increase longer term, that stock will outperform significantly. That has been my thesis since I first bought a money management stock in 1990 and its still the case today.
If its not permanent loss, then it can come back. What is permanent loss -- the bond insurers, many of the banks and brokers are either not coming back or they won't for so long it doesn't matter. If 5 years from now Citibank is still between 25 and 35 can you really say its come back? that is a very likely possibility.
I have losses in Asian funds but they are holding up better than some of my stocks -- still lots of money there and since they haven't declined as much there is still a chance to save some before they drop so that I could buy back in -- something I debated doing with the energy fund I have -- so close to raising some cash but just didn't do it.
CME -- that stock has definitely surprised me in terms of the violence of its decline. I think its about solvency -- they are the clearinghouse for their exchange so they take on counterparty risk and in a doomsday scenario that could be significant. There is also the thought that too many financial players will be wiped out and that will lower trading volumes for a long time -- bear markets equal lower volumes. Remember the oppositve of love isn't hate its apathy. Apathetic investors/traders don't trade a lot. To demonstrate just how expensive CME got (and I did mention that on this blog when it hit $700) the stock has dropped over 150 per share and yet the PE is STILL over 27x and that assumes upside to current estimates.
TSRA is beginning to reflec t a positive outcome on their litigation -- I think the move is early but that stock is up over the last few months, while the market is getting crushed. I figure many large investors think they have nothing to lose at this point -- in the last week the stock got to $36 yet post win earnings could be $3 -- not really paying much for that win yet so many probably figure the downside isn't too bad especially relative to other tech, which seems to be dropping like a rock and the upside is huge if they win. stock could easily be in the $50's post win.
scary thoughts -- look at a 10 year chart of the S&P 500 -- sure looks like a double top to me -- think we are headed back to retest the lows? That's around 770 on the index or quite a drop from here. Not many in 2002 thought we could get back to the old highs anytime soon -- most assumed it would take 10-15 years. Instead it took about 4-5 years. But the other analogy is to the 70's -- commodities, war, inflation, bad monetary policy (Greenspan), rising taxes, dollar dropping to dangerous levels, etc. Could we see the same results -- a move back to the lows over the next 2-3 years only to see the old highs again a few years after that? Back in 2000-2002 many said we were heading for 15+ years of flat markets -- so 7 years so far, add 2-3 for a downturn and 4-5 for the next upturn and you get pretty close to 15 years where the S&P 500 fluctuates between 800 and 1600. its possible but who knows -- I'm not betting that way and even if it does pan out there will be plenty of opportunities to make money.
Have I lost any permanent capital in DFR? perhaps but I'm not giving up yet. They still seem to be a viable business to me and one that is very cheap. They are smart fellows and they have a good plan. I have far more faith in the value of their assets than in any of the banks or brokers because their track record is very impressive.
Have I lost permanent capital in any of the other holdings? definitely don't think so -- AB is a high beta stock that goes up AND down faster than the market. As long as they have positive cash flows over time and are able to maintain margins and the global equity markets increase longer term, that stock will outperform significantly. That has been my thesis since I first bought a money management stock in 1990 and its still the case today.
If its not permanent loss, then it can come back. What is permanent loss -- the bond insurers, many of the banks and brokers are either not coming back or they won't for so long it doesn't matter. If 5 years from now Citibank is still between 25 and 35 can you really say its come back? that is a very likely possibility.
I have losses in Asian funds but they are holding up better than some of my stocks -- still lots of money there and since they haven't declined as much there is still a chance to save some before they drop so that I could buy back in -- something I debated doing with the energy fund I have -- so close to raising some cash but just didn't do it.
CME -- that stock has definitely surprised me in terms of the violence of its decline. I think its about solvency -- they are the clearinghouse for their exchange so they take on counterparty risk and in a doomsday scenario that could be significant. There is also the thought that too many financial players will be wiped out and that will lower trading volumes for a long time -- bear markets equal lower volumes. Remember the oppositve of love isn't hate its apathy. Apathetic investors/traders don't trade a lot. To demonstrate just how expensive CME got (and I did mention that on this blog when it hit $700) the stock has dropped over 150 per share and yet the PE is STILL over 27x and that assumes upside to current estimates.
TSRA is beginning to reflec t a positive outcome on their litigation -- I think the move is early but that stock is up over the last few months, while the market is getting crushed. I figure many large investors think they have nothing to lose at this point -- in the last week the stock got to $36 yet post win earnings could be $3 -- not really paying much for that win yet so many probably figure the downside isn't too bad especially relative to other tech, which seems to be dropping like a rock and the upside is huge if they win. stock could easily be in the $50's post win.
scary thoughts -- look at a 10 year chart of the S&P 500 -- sure looks like a double top to me -- think we are headed back to retest the lows? That's around 770 on the index or quite a drop from here. Not many in 2002 thought we could get back to the old highs anytime soon -- most assumed it would take 10-15 years. Instead it took about 4-5 years. But the other analogy is to the 70's -- commodities, war, inflation, bad monetary policy (Greenspan), rising taxes, dollar dropping to dangerous levels, etc. Could we see the same results -- a move back to the lows over the next 2-3 years only to see the old highs again a few years after that? Back in 2000-2002 many said we were heading for 15+ years of flat markets -- so 7 years so far, add 2-3 for a downturn and 4-5 for the next upturn and you get pretty close to 15 years where the S&P 500 fluctuates between 800 and 1600. its possible but who knows -- I'm not betting that way and even if it does pan out there will be plenty of opportunities to make money.
Thursday, January 17, 2008
DFR
The stock had a great day wednesday despite the tough market. Not hard to understand why -- lots of financials rallied and given that the insiders (including management and the Dart family) own about 28% of the stock and about 20% is sold short (roughly because I'm not sure if my total share count is right given the merger), the stock can fly at any moment.
So after hours the company issues news and overall its fine but there are some issues. First some writeoffs but really these are just recognizing in the income statement what has mostly been reflected on the balance sheet already -- accounting crap but not a big deal. They sold the pinetree CDO, which is the one with their subprime exposure. Since they had completely written off their exposure to the CDO the sale has no impact -- except they may have been receiving management fees and if they sold that too that's a hit to income.
They sold $1.5 bill in RMBS to improve liquidity. hmmm.... Well let's give them the benefit of the doubt and assume they proactively sold them to boost liquidity (as in better safe than sorry) as opposed to the uglier version, which is that the dealers they are getting their repos from changed the terms and made the deal uneconomical. Near term more liquidity is a good thing, but it does hurt the amount of income the portfolio can generate. On the other hand they are constantly reinvesting cash flows (regular monthly payments of P and I plus pre-payments) and over the last few months the spread between what they pay and what they earn has widened -- i.e. more income per dollar of assets.
I'm hoping these two issues offset eachother to some extent -- I'm also assuming they will reinvest the equity from that RMBS sale at reasonable rates of return sometime soon. Leverage is great isn't it? helps on the upside but makes life a little tricky on the downside.
So dilution from the deal, less leverage, sold the pinetree, etc. -- raises the question of what the dividend will be for the next year. They will likely pay out a higher amount than they earn because they didn't pay everything they earned last year. so let's assume they pay out around $1.60 but only earn $1.40. Even on the earned amount that is still almost a 20% yield. With that high a yield plus a 30-40% discount to book value plus the potential to grow the dividend over time (alternative assets, higher money management fees, etc)? that's a great deal in my book.
Some probably wonder why the stock is so cheap -- simple -- too many investors doubt their ability to survive. To them the dividend yield is meaningless. How could that happen? Well for the month of August and September the concern was liquidity but since then everyone has learned the real issue: solvency. Who will remain solvent. Obviously Countrywide wasn't going to remain solvent for long -- that's why they sold out to B of A.
Deerfield uses a lot of leverage, which minimizes the amount of price declines the assets have to suffer before the collateral (equity) is used up. The part I am not sure about is all the different pieces of DFR -- I would think even in a worst case scenario some parts might come into trouble but other parts would survive or be able to bail out the rest. The management company to me is the main savior -- other than the sellers note there is no debt. I would argue that the management company accounts for a significant part of the value of the total company right now.
The key assumption is the accuracy of the asset values used to calculate the book value estimate of 11-12 dollars. how solid are those numbers? right now in fixed income, not much outside of US treasuries are truly solid. One other point DFR made was to say that starting Jan 1 2008 they will be doing fair market value pricing as part of their accounting -- not sure what that means but hopefully they have been doing something close to that already. I have a lot of faith in the deerfield people -- they have an amazing ability to analyze credit risks based on their results during the last credit cycle bust in the 2000-2002 time period. They have a good structure and a great plan. I believe they will get through these issues and thrive in the future.
Oh, if mortgages fall enough in price to endanger DFR, perhaps we should all be shorting all the banks and maybe FNM and FRE too.
So after hours the company issues news and overall its fine but there are some issues. First some writeoffs but really these are just recognizing in the income statement what has mostly been reflected on the balance sheet already -- accounting crap but not a big deal. They sold the pinetree CDO, which is the one with their subprime exposure. Since they had completely written off their exposure to the CDO the sale has no impact -- except they may have been receiving management fees and if they sold that too that's a hit to income.
They sold $1.5 bill in RMBS to improve liquidity. hmmm.... Well let's give them the benefit of the doubt and assume they proactively sold them to boost liquidity (as in better safe than sorry) as opposed to the uglier version, which is that the dealers they are getting their repos from changed the terms and made the deal uneconomical. Near term more liquidity is a good thing, but it does hurt the amount of income the portfolio can generate. On the other hand they are constantly reinvesting cash flows (regular monthly payments of P and I plus pre-payments) and over the last few months the spread between what they pay and what they earn has widened -- i.e. more income per dollar of assets.
I'm hoping these two issues offset eachother to some extent -- I'm also assuming they will reinvest the equity from that RMBS sale at reasonable rates of return sometime soon. Leverage is great isn't it? helps on the upside but makes life a little tricky on the downside.
So dilution from the deal, less leverage, sold the pinetree, etc. -- raises the question of what the dividend will be for the next year. They will likely pay out a higher amount than they earn because they didn't pay everything they earned last year. so let's assume they pay out around $1.60 but only earn $1.40. Even on the earned amount that is still almost a 20% yield. With that high a yield plus a 30-40% discount to book value plus the potential to grow the dividend over time (alternative assets, higher money management fees, etc)? that's a great deal in my book.
Some probably wonder why the stock is so cheap -- simple -- too many investors doubt their ability to survive. To them the dividend yield is meaningless. How could that happen? Well for the month of August and September the concern was liquidity but since then everyone has learned the real issue: solvency. Who will remain solvent. Obviously Countrywide wasn't going to remain solvent for long -- that's why they sold out to B of A.
Deerfield uses a lot of leverage, which minimizes the amount of price declines the assets have to suffer before the collateral (equity) is used up. The part I am not sure about is all the different pieces of DFR -- I would think even in a worst case scenario some parts might come into trouble but other parts would survive or be able to bail out the rest. The management company to me is the main savior -- other than the sellers note there is no debt. I would argue that the management company accounts for a significant part of the value of the total company right now.
The key assumption is the accuracy of the asset values used to calculate the book value estimate of 11-12 dollars. how solid are those numbers? right now in fixed income, not much outside of US treasuries are truly solid. One other point DFR made was to say that starting Jan 1 2008 they will be doing fair market value pricing as part of their accounting -- not sure what that means but hopefully they have been doing something close to that already. I have a lot of faith in the deerfield people -- they have an amazing ability to analyze credit risks based on their results during the last credit cycle bust in the 2000-2002 time period. They have a good structure and a great plan. I believe they will get through these issues and thrive in the future.
Oh, if mortgages fall enough in price to endanger DFR, perhaps we should all be shorting all the banks and maybe FNM and FRE too.
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