Capitulation or Just Another Leg Down?

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September 30, 2008 | Stocks | Author Asif

For the first time yesterday this bear market felt like the painful bear market I experienced after the dot com bubble and I could almost feel the fear and despair coursing through the market as the Dow Jones Industrial Average crashed 777.7 points or 7% because Congress rejected the $700 billion bailout plan. The day of unlucky 7s was a historic day because it represented the largest one day point drop in the Dow. However this does not compare with Black Monday experienced in 1987 when the Dow shed 508 points or 22.6% in a single day. The Dow would have had to drop 2,518 today to match that performance.

Watching the emails, IMs and calls I received along with the stories in every form of media, it certainly felt like a day of capitulation. The market had called Congress’s bluff. As the Editor-in-Chief of David Callaway so eloquently put it in his article,

“…the S&P 500 Index plunged to its worst day since the week of the 1987 stock-market crash, wiping out more than $700 billion in the index’s market value. In other words, we all just spent that $700 billion today — and still didn’t get a rescue plan.”

While I was totally against the original $700 billion bailout plan that felt like a blank check to Treasury Secretary Henry Paulson, the alternative of doing nothing is even worse. This liquidity crisis is going to affect everything from the ability of businesses getting lines of credit to students obtaining loans for college. As Mark Zandi, the Chief Economist at Moody’s mentioned in yesterday’s Nightly Business Report,

“I have a lot of clients, big clients, clients with names that you would know. And I’m getting calls from them telling me that they’re having trouble getting working capital. That is the cash they need to make payroll to go out and finance the inventories, to finance exports. And it’s not in just one industry, it’s in lots of different industries. And it’s not just small companies. It’s big — it’s very large companies. So this highlights the stress.

Bottom line, credit is the mother’s milk of economic activity. Without it the economy doesn’t function and that credit comes from Wall Street and the financial system more broadly. And if Wall Street is not working, neither will Main Street. And it’s not next year, it’s really next month.”

The Dow is now off 26.82% from its peak on October 9, 2007, while the S&P 500 is off 29.3% over the same time period. The Nasdaq, which mostly consists of tech heavyweights with tons of cash on their balance sheets oddly enough took the hardest hit today falling 9.14%. Having sold the last of our short positions a little over 10 days ago, the SINLetter model portfolio took an equally hard hit. With the caveat “historic performance is not indicative of future results” in mind, let us examine the length and severity of bear markets since the Dow Jones Industrial Average was created in 1896. According to this article by John Prestbo,

“The average bear market over the past 111 years sent the Dow down by 34.63%. The declines ranged from 53.57% on the deep side (1932) to the shallowest drop of 21.16% (1990). They lasted, on average, nearly 11.5 months, ranging from 36.55 months (1946-49) to 1.81 months (1987).”

I have little doubt in my mind that this bear is going to be deeper and longer than the average bear market because the process of deleveraging is going to take some time both for Wall Street and Main Street. However we may have already experienced a bulk of the decline and liquidating long positions at this point does not make much sense. It may be tempting to start bargain hunting but what appears cheap tends to get cheaper in a bear market. I would be very selective and patient about adding new positions or adding to existing positions.

The Indian BSE Sensex, which dropped more than 500 points yesterday to 12,595.75 is actually up more than 140 points today as I write this blog entry. Given its 40% decline since January 2008 and India’s long-term growth prospects, the Indian market might be a better place to hunt for bargains.

Note: Due to time constraints, the next investment newsletter that is due out tomorrow, will be delayed until Monday, October 6th .

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The Rules Of The Game Have Changed

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September 21, 2008 | Stocks | Author Asif

In an unprecedented move, the current administration unveiled a simple three page plan on Saturday that will provide the treasury with $700 billion to buy toxic assets off the balance sheets of financial institutions. Combining this bailout plan with the $85 billion loan to AIG and the $200 billion to rescue Fannie and Freddie, we the taxpayers are eventually likely to incur a bill of $1,000,000,000,000. In case you did not have the time to count all those zeros and calculate what you might be liable for, that is $1 trillion and works out to a little over $3,250 for every man, woman and child living in the United States.

We have come a long way in this crisis that has devoured most of the independent mortgage lenders and left just 3 out of the 6 investment banks that started this year. Almost every weekend there is news of yet another small bank going under and real estate shows no signs of turning around. Nearly 47% of all homes sold in the state  of California last month were foreclosures and the median home price in the San Francisco bay area fell from $655,000 in August 2007 to $447,000 last month.

Following in the footsteps of our neighbors across the pond, the SEC temporarily banned short selling in the stocks of 799 financial institutions in an orchestrated effort to shore up markets. While I felt that the SEC’s move to ban naked short selling was a good move, I think a ban on short selling of any kind makes no sense. Essentially we can only buy stocks to go long or sell our existing positions but cannot hedge our portfolios by selling stocks that may be overvalued?

Short selling is an activity that even noted British economist John Maynard Keynes indulged in as far back as 1919 and is not the evil activity it is being painted out to be in the media. Try telling fund managed Ken Heebner who graced the cover of Fortune magazine just a few months ago that he has to change the structure of his 130/30 fund (130% of assets are invested in long positions and 30% are invested in short positions) because he can no longer sell short even if he identifies overvalued or mismanaged companies in the financial sector.

In its press release regarding the short selling ban the SEC admits, “Under normal market conditions, short selling contributes to price efficiency and adds liquidity to the markets.”. Clearly this action is targeted towards institutions that were aggressively short selling financial stocks and unless extended, it should end on Oct 2, 2008. Thankfully naked put options and the ultrashort ETFs, our instruments of choice to hedge the SINLetter model portfolio, were not included in the ban.

So how are investors going to be affected by these events? We are going to see increased volatility in the market, especially in the financial sector, which has been handed a Christmas gift a few months in advance. As mentioned in my previous blog post, we added to our position in Barclay’s (BCS) on Wednesday evening and the stock appreciated almost 44% in the following two trading sessions. There is a good chance we might see financials continue to rise over the next few weeks until the next earnings season comes along.

Since this was clearly a bailout of Wall Street and not Main Street (some democrats are calling for an additional stimulus package for taxpayers as part of this plan), the economy is likely to continue sputtering along or even worsen in coming months. Retail and especially luxury goods are likely to continue weakening. I still remember hearing arguments last year that this cycle will not affect the upper echelons of society and hence luxury goods will not be affected as much as the regular retail sector. Looking at the one year graph of the SPDR S&P Retail ETF (XRT) and the Claymore/Robb Report Global Luxury ETF, which ironically (or cleverly) trades under the symbol ROB, it is clear that luxury has performed worse than the rest of the retail sector and I believe this trend is likely to continue.

It may not be too late to short either one of these ETFs or start a position in the Proshares Ultrashort Consumer Services ETF (SCC). SCC is based on the Dow Jones U.S Consumer Services Index, which in addition to retailers also includes hotel, car rental, airline and cruise line companies. You can find its entire list of holdings here (excel file).

We are already beginning to see the dollar weaken against other currencies and the best way to play this (besides shorting the dollar) could be to take long positions in other currencies through ETFs like Currency Shares Australian Dollar Trust  (FXA), Currency Shares British Pound Sterling Trust  (FXB), Currency Shares Canadian Dollar Trust  (FXC) or Currency Shares Swiss Franc Trust (FXF). If picking a specific currency is too daunting a task (it is for me), then the “carry trade” ETF PowerShares DB G10 Currency Harvest Fund (DBV) could provide a useful alternative. The simple premise of this ETF is that higher yielding currencies tend to outperform lower yielding ones and hence this ETF goes long the highest yielding currencies while simultaneously shorting the lowest yielding currencies. You can learn more about the carry trade and DBV from this BusinessWeek article titled Trade Currencies Like A Hedge Fund.

Bond prices have also dropped in anticipation of the U.S government issuing more debt to finance this bailout. Most homeowners tend to either move or refinance their homes within a 10 year period. Hence 30 year mortgages are closely correlated to the 10 year Treasury note and have already jumped last week in response to this bailout plan. Not only are financial institutions being given a “get out of jail free” card but responsible first time home buyers who waited out the real estate bubble are going to pay the price immediately through increased financing costs.

I may act upon some of these strategies (short retail, currency carry trade, etc.) in the near future based on market developments and if I do, I will post it on the blog or in the next investment newsletter that is due out on October 1st.

Voluntary Disclosure: I hold a long position in Barclays (BCS).


Lehman Fails, The Last Act Begins

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September 16, 2008 | Stocks | Author Asif

The tremors from the failure of Lehman Brothers (LEH) are still being felt across the globe in what I feel might be last act in the financial meltdown we have experienced this year. As I read the announcement of Lehman’s decision to declare bankruptcy on Sunday night, I watched the Indian stock market crash with the BSE Sensex dropping more than 800 points to 13,150 before recovering to close at 13,531, a loss of 470 points or 3.35%. Much of Europe shared a similar fate with London’s FTSE 100 dropping 3.92%. In contrast the 250 to 300 point loss that the Dow posted through most of the trading session on Monday felt like a muted response until things fell apart in the last hour of trading and the Dow Jones Industrial Average closed the day with a loss of 504.48 or 4.42%. Tuesday seems to be shaping up as another day of losses with the BSE Sensex dropping nearly 400 points in the first few minutes of trading before recovering some of those losses, the Japanese Nikkei index dropping 5% (the Japanese market was closed on Monday) and FTSE 100 falling 1.5%.

The obvious question on every active investor’s mind is “what now?”. While having lunch with a friend from Smith Barney yesterday, he mentioned how this bear market was different from the one we experienced after the dot com bubble burst where one could at least find some sectors or asset classes like bonds that continued to perform well. This market is directionless and almost every sector, country and asset class seems to be going down in unison.

After its recent pullback to $786.30 per troy ounce, Gold and some of the senior gold mining companies like Newmont Mining (NEM) and Barrick Gold (ABX) are beginning to look attractive. I am also tempted to start positions in some of the stocks that are on the top of my watchlist including Flextronics (FLEX), Oregon based scrap metal company Schnitzer Steel (SCHN) and Indian mining company Sterlite Industries (SLT), which has been hit hard in recent weeks due to a corporate restructuring and a deflating commodities market.

It was just last week when I mentioned in the blog entry Taking Profits in Umpqua Holdings (UMPQ) that “we may be entering the last act of the downturn in financial stocks but I feel that we have not hit the bottom yet”. That sentiment remains unchanged and it may still be prudent to hold back and not attempt to catch falling knifes or pick market bottoms in this highly volatile market. With our short pick Ultrashort Russell 2000 (TWM) up almost 12% since we doubled our position in it at the start of September, I may close out the position and take some profits in the near future. If I decide to add or close positions in the SINLetter model portfolio, I will post the decision on the blog before making any changes.

Voluntary Disclosure: I hold a position in Ultrashort Russell 2000 (TWM) in my personal portfolio.

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Copter Crisis: Investment Opportunity?

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May 12, 2008 | Stocks | Author Asif

In the May 12th edition of Fortune Magazine, there is an interesting article titled Copter Crisis that delves into how the growth in offshore drilling for oil and gas has led to increased utilization of helicopters to get to and fro from the offshore platforms. This offshore drilling boom combined along with increased usage of choppers for private travel has lead to a shortage of helicopters and their parts. I figured I would attempt to provide more color on chopper related investments through this blog entry.

Based on the earnings forecast of offshore drillers like Transocean (RIG), Diamond Offshore Drilling (DO) and Noble (NE), the offshore oil drilling boom is likely to continue for years to come. In fact Transocean earned over $1 billion in just the first quarter of this year. We picked up Diamond Offshore Drilling (DO) for the SINLetter model portfolio in January 2007 and have been rewarded with a gain of over 70% over 16 months despite the recent pullback in the stock. Diamond Offshore was a proxy investment for rising oil prices and it appears that choppers could be a proxy for the offshore drilling boom based on the number of large offshore oil finds in the Gulf of Mexico and off the coast of Brazil over the last few years.

Four popular chopper models were mentioned in the sidebar accompanying the Fortune article. The Sikorsky S92 and S76 used for executive travel and by offshore drillers, the smaller AW119 Ke used by traffic reporters and the larger Boeing Chinook used to transport civilian cargo.

Given below is a list of public, private and international helicopter companies that make the models listed above and many others.

  1. Long Island, New York based Sikorsky Aircraft is a division of the diversified industrial company United Technologies (UTX) and makes the famous Black Hawk chopper as well as nearly half the maritime choppers used by armed forces around the world.
  2. The Boeing Chinook as the name implies is made by Boeing (BA).
  3. The AW119 Ke is made by AgustaWestland, a division of Italian company Finmeccanica. 2007 revenue for Finmeccanica came in at 13.429 billion Euros, an 8% increase year-over-year and net income was 521 million Euros, a drop of nearly 50% year-over-year. However after excluding extraordinary items that affected both 2007 and 2006 results, net profit jumped 49% to 503 million Euros from 337 million Euros in 2006. Finmeccanica  is quoted on various exchanges such as London (FNA.L), Milan (FNC.ML), Berlin (FMNB.BE) as well as over-the-counter (OTC) in the “grey market” (FINMF.PK). If you use a full service broker or E*Trade Global Trade and like the prospects of Finmeccanica, you could pick up the stock from the London Stock Exchange (LSE). Beyond helicopters, the company also has a hand in everything from high speed trains to homeland security in the United States. Finmeccanica is said to be in talks to acquire New Jersey based defense company DRS Technologies (DRS). If you have any social qualms about investing in a defense company, then Finmeccanica may not be your play as the company derives a majority of its revenue from defense electronics. Helicopters are the second biggest division of the company representing 22% of 2007 revenues.
  4. If you prefer a pure play instead of a large industrial company like United Technologies or a company listed on the LSE, you could also consider Kaman (KAMN), a helicopter and industrial distribution company quoted on the Nasdaq. Kaman has a market cap of $666.71 million and appears to be attractively valued with a forward P/E of 11.18 and P/S of  0.57 while sporting an above average 2.2% dividend yield.
  5. While not a pure play, another company to consider is Bell helicopter, which is a subsidiary of aerospace giant Textron (TXT). Textron was ranked number one in the Aerospace & Defense category of Fortune magazine’s list of America’s Most Admired Companies of 2008. As an added bonus, investing in Textron also gives you exposure to the red hot light jet segment as the company also makes the Cessna line of jets. The light jet theme was something I discussed while featuring Brazilian aircraft maker Embraer (ERJ) in the August 2007 edition of my investment newsletter.
  6. European aviation giant EADS (EAD.PA), more commonly known as the parent of Airbus, also has a helicopter division called Eurocopter that makes various models of both civil and military choppers. EADs is listed on various international markets such as Paris and Frankfurt. After suffering setbacks due to the delayed launch of the A380 superjumbo liner, the stock has been in a downward trajectory since 2006 and is now at levels not seen since 2003.
  7. The Robinson Helicopter Company  according to their company website “produces more helicopters annually than all of the other North American manufactures combined”. Unfortunately Robinson is a privately held company that may only be accessible to deep pocketed private equity investors or hedge funds. According to the Fortune article, the biggest helicopter operator CHC Helicopter Corporation was recently acquired by private equity firm First Reserve for $3.7 billion. Other privately held helicopter companies include Enstrom Helicopter, RotorWay International, Brantly and MD Helicopters.

A table comparing the public companies  mentioned in this article is given below.

Public Chopper Companies

Company Symbol Price P/E Forward P/E P/S Div Yield Est Revenue Growth
United Technologies UTX $73.13 16.34 13.42 1.29 1.70% 9%
Boeing BA $84.06 14.58 12.03 0.95 1.90% 3%
Textron TXT $60.87 16.28 13.18 1.11 1.5% 13.3%
Kaman KAMN $25.16 11.57 11.18 0.57 2.2% 9.3%
Finmeccanica FNC.MI 21.44 € 18.84 - - 1.91% -
EADS EAD.PA 15.6 € (27.86) - - 0.77% >2.24%

If I had to pick two companies from this list to invest in, I would pick Textron (TXT) and Kaman (KAMN) based on their current valuation, estimated 2008 revenue growth rates and because they seem to be the closest to pure plays. I am going to add these two companies to our watchlist and may add them to the model portfolio and my personal portfolio in the future.

Voluntary Disclosure: I do not own any positions in any of the companies mentioned in this blog entry.


  1. Finmeccanica 2007 Financial Statements (PDF)
  2. EADS 2008 Guidance
  3. EADS Key Figures


NetSuite Beats Earnings, Stock Plunges After Hours

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May 2, 2008 | Stocks | Author Asif

Correction (5/6/2008): As the Senior Director of Investor Relations from NetSuite correctly pointed out to me in an email yesterday, NetSuite beat analyst earnings expectations by a penny a share instead of missing earnings by a penny as I had originally mentioned in this blog entry. Earnings according to GAAP (Generally Accepted Accounting Principles) have included stock based compensation as an expense since the rule went into effect in 2005 and NetSuite reported a GAAP loss of 3 cents a share. The mistake I made was to compare the GAAP loss of 3 cents a share against analyst expectations of a 2 cent loss, which did not include stock based compensation. NetSuite’s earnings excluding stock based compensation was a loss of one cent a share, hence beating estimates by a penny.

On-demand software provider NetSuite (N) reported its first quarterly results as a public company yesterday with a 3 cents a share or $2 million loss, which came  in below above analyst expectations of a 2 cent loss. The stock registered a sharp drop in reaction to the results, falling $3.81 or 17.08% in after hours trading. It appears that my concerns about NetSuite’s valuation, as published in the April investment newsletter, were well founded. However it is always a good idea to go beyond the headlines (even mine) and take a deeper look.

Based on what I heard in the conference call, NetSuite had a strong quarter with $34.1 million in revenue that topped analyst estimates and $1.5 million in cash flow from operations. Management sounded confident on the call and they raised their 2008 revenue forecast to a range of $154 to $157 million.

The only logical explanation for the after hours sell off would be that investors were probably expecting NetSuite to meet or exceed earnings expectations and were not satisfied by the 47% growth in Q1 revenue. As mentioned in my last article about NetSuite, growth in the last four quarters was 71.64%, 64.28%, 56.35% and 57%. As the law of big numbers starts catching up (it is usually harder to grow from $100 million to $200 million than it is to grow from $10 million to $20 million, even though both scenarios represent 100% growth), it is not uncommon to see growth moderating.

Additional highlights from the conference call are given below,

  • First quarter 2008 revenue grew 47% to $34.1 million when compared to Q1 2007 and increased 8% when compared to the previous quarter (Q4 2007).
  • The company posted a net loss of $2 million or 3 cents per share. On a non-GAAP basis after excluding stock based compensation, the company posted a loss of $420,000 or 1 cent per share when compared to a non-GAAP loss of $842,000 in the previous quarter.
  • NetSuite posted a smaller loss this quarter by reducing external professional services and because revenue growth outpaced expense growth. Gross margin came in at 71% (typically high for software companies) when compared to 70% in Q4 2007.
  • As expected NetSuite’s investment in a data center (the company mentioned spending $10 to $15 million in its IPO filing) will impact gross margins throughout 2008.
  • The company signed up 400 new customers in the first quarter, which is within the range of 300 to 500 customers they have historically signed up in previous quarters.
  • International revenue grew faster than domestic sales with a 64% growth rate and international revenue now represents 19% of total revenue.
  • NetSuite appears to be excited about its new OneWorld product with 30 companies like Six Apart (the makers of TypePad blogging software) live on this product and another 50 currently under implementation. NetSuite OneWorld has helped one of their customers manage 100 subsidiaries using the software.
  • British Telecom, one of the resellers NetSuite is working with, will help introduce NetSuite products to 1.6 million small business customers in the United Kingdom and Europe.
  • Subscription revenue renewal rate was 90% of revenue in Q1 2007. Upselling other products to current customers has usually offset churn and effectively helped NetSuite retain 100% revenue. It would have been interesting to see what the attrition rate was quarter-over-quarter instead of year-over-year and even a 10% rate of churn appears a little high.
  • The company recently announced the NetSuite E-Commerce Company Edition product and the NetSuite Business Operating System or NS-BOS for developers. It estimates that nearly 1,000 developers are using NS-BOS to develop industry specific applications.
  • The first quarter of 2008 represented the 34th straight quarter of revenue growth and 10th quarter of improving non-GAAP results.
  • The company recognized $1.5 million in revenue from the distribution rights of their Japanese product. It expects to continue recognizing similar revenues for the rest of 2008.
  • Product development expenses grew 2% quarter-over-quarter to $3.6 million. The company expects to spend 12 to 13% of total 2008 revenue on product development.
  • Marketing and sales expenses grew 11% to $7.5 million primarily due to hiring in their new sales office. The company expects to significantly increase hiring in sales and marketing in 2008.
  • NetSuite experienced a sharp 28% increase in general and administrative (G&A) expenses to $5 million. This increase when compared to Q4 2007 was on account of being a public company. G&A is typically high in the first quarter for NetSuite and the company expects G&A expenses to come in at 12 to 13% of revenue in 2008.
  • 35% of Q1 2008 expenses were in currencies other than US dollars. This could be on account of their global support centers and may not bode well for the company in a strengthening dollar environment as it expects this percentage to grow.
  • The company hired 99 new employees in Q1 and plans to hire a total of 350 employees in 2008, mostly in sales and marketing. The employee headcount stood at 765 at the end of the first quarter.
  • The company recorded a $229,000 income tax provision in Q1 2008.
  • Cash flow from operations was $1.5 million compared to $3.7 million in Q4 2007 and -$0.5 million in Q1 2007. Year end bonuses and commissions reduced cash flow in the first quarter.
  • Capital used in investing activities such as hosting account capacity and equipment purchases was $1.1 million when compared to $1.4 million in Q4 2007 and $1.4 million in Q1 2007.
  • Free cash flow was $379,000 in Q1 2008 when compared to negative $1.9 million in Q1 2007.
  • The balance sheet currently had $170.2 million in cash. Accounts receivables dropped to $16.2 million from $18.7 million at the end of 2007. As a customer I can attest to NetSuite’s cash collection capabilities.
  • Short-term deferred revenue (their pipeline, if you will) was $67.1 million, an increase of $1.3 million from the end of 2007. Long-term deferred revenue was $8.9 million, a decrease of $2.2 million from the prior quarter as the company shifts from multi-year contracts to annual contracts and some revenue from their Japanese product became current.
  • Stock based compensation declined to $1.6 million when compared to $2.4 million in Q4 2007.
  • NetSuite plans to reinvest most of its top line growth into the company and plans to add 2% to the bottom line every year.
  • The company projects Q2 2008 revenue of $36 to $36.7 million and a loss of $1 million to $250,000.
  • NetSuite increased its full year 2008 forecast to a range of $154 to $157 million and expects to post a non-GAAP loss of $2.4 million to $1 million. With an expected 61.3 million shares outstanding at the end of 2008, this should translate into EPS of -4 to -1 cents.
  • If you get a chance to listen to the conference call, check out the comments about SAP in the Q&A section towards the end of the conference call.

Voluntary Disclosure: I currently hold no positions in NetSuite.

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