Future Sight: April 2009

Saturday, April 11, 2009

Incredible understanding and explantation of societies evolution into the web

Copyright Jonathan Rose 2009 - Creative Commons License

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What happens when the leveraged buyout firms deleverage

The definitive users of leverage over the last 3-5 years have been the private equity funds; Blackstone, Fortress, APAX partners, KKR and the Carlyle Group to name a few. They have raised billions for leveraged buyouts, far beyond the scale of anything ever seen before. They acquired a company they felt has too much fat, trimmed it down to size - increasing profitability. This then allows them to resell, IPO or otherwise exit within a 3-5 year period with fabulous profits.

I expect many of these Private Equity Funds including Fortress, KKR and Blackstone to start to unravel within the coming months, as their short term loans (used to purchase the companies) come due. Fortress Investment Group (FIG.N) had a very public issue with Intrawest last Fall when they had to refinance a $1.7Bn loan and struggled immensely. When your facilities terms get worse you have to pay more money for the same service which is a direct hit to bottom line. They will also be impacted as they will not be able to service the increased costs of the debt as a result of their reduced revenues caused by the global depression, furthermore they will not be able to raise the capital needed refinance, cover shortfalls or to fuel any further growth. Thus they will be unable to hide red spots hidden within their balance sheets and we will see the beginning of a Bankruptcy season that will last throughout 2009 and well into 2010. The Private Equity funds are very well run and managed though so you can guarantee the assets are so well ring fenced that they are unaffected (bar some loss of principle) when each layer of the onion is peeled back. They will rise again to prominence in them middle of the next decade as the few assets they maintain become valuable and they are able to sell them off for a good profit. I think RailAmerica, Inc and FECI should be a great performers long term as they are cash flow businesses with incredibly high barriers to entry.

On a Micro Level looking at one of Fortresses assets that is underperforming; Intrawest. I cannot foresee them lasting the summer on heavily reduced 2009 numbers. They have frozen and rolled back salaries, lost their insurer in Liberty Mutual, seen decreased skier visits and revenue and worst of all were established using a finite model as most of their revenue and profits come form the development and sale of real estate and not the running and management of ski resorts.

Short (FIG.N).....

Intrawest's failure should spill over onto the other ski resort operators in the market and make for short term shorting opportunities and long term buying opportunities.

Thus as a small short term idea I plan to play with is:

Short Vail Resorts (MTN)

Even though their numbers are pretty reasonable, (probably a good buy at $10 at the end of 2011 season) seeing as the depression did not hit Denver till later in the season after everyone bought their season tickets (24% of revenue in 2005 to 34% in 2009). They will probably suffer immeasurably more next season.

Intrawest will probably file for the Canadian version of a CH 11 reorganization and break off the Colorado Resort in to one division, East Coast Resorts into another, maintaining Whistler Blackcomb, Tremblant and their Canadian Resorts until after the 2010 Olympics when they will hope that renewed skiing interest and revenues will save them.

Intrawest has already divested themselves of most of their stake in Mammoth and that leaves Sandestin and Lake Las Vegas to be sold of to private investors. I would presume that the Colorado resorts would be sold off as Copper Mountain is a true "dog" and is in the Vail Resorts Epic pass stronghold of Summit County and cannot compete. They are really a great purchase for Vail resorts but the monopolies and mergers commission will probably not allow the sale.

Steamboat will probably be sold to a private individual and will make a great destination resort and Winter Park which is 50% owned by Denver will probably be picked up by one of a few small groups of private investors; possibly including "George Gillette Jr" former owner of Vail who has been poking around in recent months.

Intrawest as started was a short term business model which is probably why the founders sold out in 2005. It was based on ever increasing real estate sales to fuel growth but due to the finite opportunities for ski resorts this market was truly limited, which is why they did so well in it in the first place. Private Equity funds sometimes lack alot of the necessary understanding of the core and underlying business which causes them to err dramatically. The thing that makes a great ski resort is great grooming and phenomenal customer service, these do not run hand in hand with a spreadsheet in Manhattan.

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Monday, April 6, 2009

What caused the crash, who should go to prison and how to fix this mess

This article could have so many titles:

Whose to Blame?

Why are the wrong people being blames?

The one reform the market desperately requires?

Where was the free market watchdog? No not the SEC......

Why are the rating agencies not owning responsibility for their mess?

Should AIG and Madoffs investors be allowed to sue the Rating Agencies?

Who owns the Rating Agencies and is keeping them out of the press???

The Rating Agencies have held themselves out as our guiding lights in investment they have built a huge business in the niche of advising us what is safe and what isn't and then hung us out to dry. They do the hard work and the heavy lifting providing us with the due diligence we require to make educated and astute investment decisions. As an savy investor you wouldn't dream of loading your pension fund with NR (unrated) or "D" grade bonds months before retirement. It is their commitment to you that your "AAA" investment will be the "best grade, reliable and stable" yet how are they held accountable when these investments prove to be anything but.

In any self regulating system there are checks and balances, many of which relate to the manner in which the market carries out due diligence and how it assesses risk. The more risk one takes the higher the return, which mitigates losses when there is some kind of implosion. The investor normally is philosophical and says, hey I took a risk and had I wont the return would have been worth it. It is the very true for anyone investing in speculative oil exploration drilling the returns will be huge and you will only invest a small portion of your portfolio. A less speculative investor will wait until oil has been hit and invest in the secondary wells drilled to tap the known reserve, you would naturally be willing to invest more in this than in the exploration. The risk averse investor will invest in the pipeline from the known field to the known refinery, this is where the majority of investors have the majority of their money, including; pension funds, insurance companies, charitable foundations, banks. The financial implosion we are currently witnessing is the result of the self regulating bodies that held themselves up as our due diligence experts telling us that we were buying a pipeline to an existing oil field from a refinery. This was the coveted "AAA" rating or even slightly lesser rating such as "A" and "AA." They failed us and if anyone should be imprisoned, punished or found fault with it is the heads of these companies who held themselves up as independent and then earned their very revenues from the companies and assets they were supposed to independently rate. This is why the market has no trust now, what was seemingly secure and therefore had such a large proportion of wealth in it is now clearly seen to be unsecure, investor confidence is shaken to the core.

This confidence must be restored and there is truly only one way to achieve this. The checks and balances need to be trustworthy and more than any other thing the current Government needs to do is make the organizations' that decide who we should believe in be honest again. Would I be mistaken in thinking that these agencies are avoiding the limelight due to their owners (McGraw Hill owns Standard and Poor's) and the vast profits (often 50% or more) this company makes for them. They are the most culpable entities in the current society. Whilst Madoff is vilified and the SEC is chastised, the rating agencies (Stand & Poor's, Fitch, Moody's) should have been the natural whistleblowers, they have skated by with barely even a mention.

I couldn't believe it when one of my potential investors asked me recently what my bonds "credit rating" was. The worthless piece of paper it would have been written on would have cost me nearly $500,000 to obtain and would have been almost entirely dependent on the information I provided carefully formatted by one of the ex-credit rating agency employees who charge $100,000 or more to guarantee you obtain certain ratings. The system is corrupted, "power corrupts and absolute power corrupts absolutely." These companies have absolute power over which investments flourish and which never make it, yet what is their process, ability and knowledge in handing out these ratings. Need I point out that Enron, Lehman, WorldCom, Texaco, Conseco, Global Crossing, United Airlines, GM, GMAC, Countrywide, KMART, Fruit of the Loom, Continental Airlines, Citibank all held high ratings and the consumers found out before the rating agencies that these were wrong.

I propose that the very first thing the government does before any more bailout money is handed to banks etc is that this system is ripped apart, either nationalize these companies or imprison anyone who gets ratings wrong due to personal gain. Make these entities culpable, why should AIG loose so much money and its investors too when they entrusted their risk quite logically to the rating agencies. People should still to what they are good at and be able to have the confidence to trust other companies in their fields of expertise. I was able to work out that Countrywide's Chairman/ CEO Angelo Mozzilo was selling his stock as fast as he humanly possibly could, it was public information, why couldn't they have raised a red flag 6-9 months earlier when I did..... its basic due diligence...... When Harry Marcopoulos raised the red flags why didn't they investigate it, it is not the SEC we turn too, to tell us if something is a good risk or a bad, it isn't the SEC that "RATES" something as "LOW RISK".

It is wonderful that these organizations create huge barriers to entry making only mega deals viable and pushing fund manager towards the limits of efficiency where returns will be compromised due to the sheer scale of the investment fund requiring investment. Warren Buffett has underperformed in recent years due to the sheer scale of his fund and that fact that opportunities are not as bountiful, he cant even look at smaller deals as the economies of scale no longer make sense. Whilst he will now make a killing because of his heavily cash weighted position he is proof that

My call is out to the people is we should punish those who should be punished even if the media wont focus on it as they own them. The people who told us to trust in garbage are not people we can trust this sector of the system is utterly corrupt and needs a complete overhaul or else we will be right back here again before you can say next generation.

Long-term credit ratings

Fitch Rating' long-term credit ratings are set up along a scale from 'AAA' to 'D', first introduced in 1924 and later adopted and licensed by S&P. Moody's also uses a similar scale, but names the categories differently. Like S&P, Fitch also uses intermediate modifiers for each category between AA and CCC (i.e., AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB- etc.).

Investment grade

§ AAA : the best quality companies, reliable and stable

§ AA : quality companies, a bit higher risk than AAA

§ A : economic situation can affect finance

§ BBB : medium class companies, which are satisfactory at the moment

Non-investment grade (also known as junk bonds)

§ BB : more prone to changes in the economy

§ B : financial situation varies noticeably

§ CCC : currently vulnerable and dependent on favorable economic conditions to meet its commitments

§ CC : highly vulnerable, very speculative bonds

§ C : highly vulnerable, perhaps in bankruptcy or in arrears but still continuing to pay out on obligations

§ D : has defaulted on obligations and Fitch believes that it will generally default on most or all obligations

§ NR : not publicly rated

Short-term credit ratings

Fitch's short-term ratings indicate the potential level of default within a 12-month period.

§ F1+ : best quality grade, indicating exceptionally strong capacity of obligor to meet its financial commitment

§ F1 : best quality grade, indicating strong capacity of obligor to meet its financial commitment

§ F2 : good quality grade with satisfactory capacity of obligor to meet its financial commitment

§ F3 : fair quality grade with adequate capacity of obligor to meet its financial commitment but near term adverse conditions could impact the obligor's commitments

§ B : of speculative nature and obligor has minimal capacity to meet its commitment and vulnerability to short term adverse changes in financial and economic conditions

§ C : possibility of default is high and the financial commitment of the obligor are dependent upon sustained, favorable business and economic conditions

§ D : the obligor is in default as it has failed on its financial commitments.

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When Will Obama Go To War

"History does not repeat itself but it does Rhyme"

Mark Twain

Barack Hussein Obama and his administration along with the "Great Depression" historian and Federal Reserve Chairman Ben Bernanke are repeating almost every move executed by Franklin Delano Roosevelt during the 1930's "New Deal." This can be seen right down to the wording of their speeches and the "fireside chats" replaced by the "town meetings" to boost the "feel good" factor.

"The only thing we have to fear is fear itself"

FDR Inauguration speech.

"On this day, we gather because we have chosen hope over fear"

Barack Hussein Obama Inauguration speech 2009

However as we enter the "greatest" depression ever in US history (see my article of September 11th 2007 http://jonsyrose.blogspot.com/2007/09/liquidity-crisis-little-reflection.html) and face what could be the end of the American Era of Global Dominance; history teaches us that the $3.5 Trillion will not be enough just as the $2.5Bn wasn't enough in 1932. The incredibly job building programs of public infrastructure that Barack Hussein Obama proposes, mimicking the 1935 public works will not be enough and the 1.5m that became homeless during the 1930's will likely and sadly repeat itself. Foreclosures are headed towards an all time high and bank lending is tightening whilst fear runs rampant throughout main street America where job security is non existent. Henry Paulson replicated the FDR bank holiday and cash injection on October 14th 2008 with some $250Bn invested in the banks in an attempt to prevent the homelessness if not the rush on banks. This didn't occur as he raised the FDIC limits to $250,000 much as FDR brought the FDIC into being to prevent or mitigate the rush in the late 1920's and early 1930's. Timothy Geitner has proposed the Public-Private Investment Program to further try to avoid the mass foreclosures but America's consumers are overleveraged as are our businesses. Spending grew out of control and the checks and balances of the economy are attempting to right the sinking ship.

Foreclosures are Inevitable

People do not earn enough to meet a three and a half time ratio for earnings unless house prices return to realistic levels. The only way to achieve this is for them to be foreclosed upon and resold. This was seen with the penny auctions in the 30's. Rents must return to being fairly close to the mortgage payment, this is, in my opinion, the essential fair value of a property and the yardstick I have always invested by. Seeing as earning cannot support higher rents then this is another reason for the overheated property market to reset. Hold off your buying for at least another 12-18 months while the government and banks realize that this is inevitable and must be done. Banks must realize and actualize their losses or the government must assume and actualize these losses through the Public-Private Investment Program.

Suicide and the Reality of Returns

Lets hope that suicides do not once again reach their height of 18 per 100,000 as during the 1930's although the high profile suicide of Rene-Thierry Magon de la Villehuchet who lost in the region of $1.3Bn with Bernard Madoff does not bode well. Bernard Madoff exposed the weaknesses and cracks in the system which cozy's up to insiders as his scheme grew to such levels that it collapsed under its own weight and demands for injections of new cash; much like Charles Ponzi's Scheme did in 1920. Harry Marcopoulos was ignored as were many others who explained that some things were too good to be true and the basic rules of math's and economics do not and cannot be changed. Greed, Euphoria and the desire to "keep up with the Jones's" kept people investing speculatively and chasing the dream of rags to riches/ overnight successes and quick millions. Even now diner tables are still filled with people talking of the one deal they invested in where they got high returns etc and ignore and gloss over all the others they lost on. The average investor doesn't achieve more than 5-6% per annum if the truth be known although to hear them talk you would think you are missing out all the time and they are raking in 15-20%.

Why Obama May Choose War

World War II resulted in the US government expending $500Bn and it still took till 1943 to restore employment (with a significant decrease in the male population) and till the late 40's-early 50's for the stock market to return to its pre 1929 high. This in modern money would be government war expenditure of in excess of $10 Trillion and probably closer to $20-30 Trillion in real terms. History teaches us this is the kind of figure necessary in simpler time with a less complex and interwoven global economy.

"These are the indicators of crisis, subject to data and statistics. Less measurable, but no less profound, is a sapping of confidence across our land; a nagging fear that America's decline is inevitable, that the next generation must lower its sights." Barack Hussein Obama Inauguration speech 2009

In Conclusion

Don't lower your sights, just remember that no one gets rich over night, there are years and normally decades of hard work that lead up to "overnight" success. Slow and steady growth of investments from savings put away on a weekly or monthly basis is what built the middle class and will rebuild it again. Solid cash flowing businesses that produce essential products and utilities will always be in demand and will provide constant dividends that if reinvested will far outperform equity value growth over decades. Think long term, the Chinese and Japanese are and they are the societies most likely to take the lead in growth and power over the next Era which I like to think of as the "Asian Era." This doesn't mean that one should discount Europe which will always be a solid performer or America, just don't expect to see the kind of dominance and world leadership that has been witnessed over the last 100 plus years.