the Contrary Investor

August 17, 2007

On the Rate Cut:

Filed under: Uncategorized — contraryinvestor @ 7:39 pm

From Long Short Capital:
Bernanke in Pictures

by Johnny Debacle

Hi, my name is Ben. I am in charge of the economy, more or less. To my left, a man far less important. To my right, Greenspan. Last night, the three of us held a secret meeting in our hidden Fed safehouse. There we drank, ate, told some amazing jokes and then decided to cut the Fed Discount Rate 50 basis points.

The rate cut was approximately this big. The technical issue as to what the Discount Rate actually means is largely irrelevant — the takeaway for you is that we cut a Rate 50 bips. Does that make you happy?

I knew it would make you happy. It made me happy too, that’s why I did it. Some have concerns that this is a ham-handed intervention into a free market and worse, a temporary salve, that will give people a delusional sense of comfort. These are really good points, so let’s switch to a profile shot.

As I mentioned above, I am in charge of the economy, more or less. And the economy, more or less, is the stock market. As you can see there is nothing temporary about today’s bump in the DJIA. Also did I mention that the Rate cut was this big?


August 16, 2007

Step away from the ledge

Filed under: General — contraryinvestor @ 1:25 pm


“If you expect to be a net saver during the next 5 years, should you hope for a higher or lower stock market during that period?”Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall.”This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.”

Warren Edward Buffett (born August 30, 1930) is an American investor and the CEO of Berkshire Hathaway.
– 1997 Chairman’s Letter to Shareholders

Take a step back, breathe, look for bargains. Repeat as necessary.

August 14, 2007

The Opposite

Filed under: General — contraryinvestor @ 11:51 am

This is my religion

castanza.jpg This excerpt is from the Seinfeld episode which changed this humble investor’s life, I give you

The Opposie:

“Why did it all turn out like this for me? I had so much promise. I was personable. I was bright. Oh, maybe not academically speaking, but I was perceptive. I always know when someone’s uncomfortable at a party. It all became very clear to me sitting out there today, that every decision I’ve ever made in my entire life has been wrong. My life is the complete opposite of everything I want it to be. Every instinct I have in every aspect of life, be it something to wear, something to eat… It’s often wrong… I should do the opposite, I should….Yes, I will do the opposite. I used to sit here and do nothing, and regret it for the rest of the day, so now I will do the opposite, and I will do something!…..This has been the dream of my life ever since I was a child, and it’s all happening because I’m completely ignoring every urge towards common sense and good judgment I’ve ever had. This is no longer just some crazy notion. Jerry, this is my religion.”

Have you driven a Ford lately?

Filed under: Ford,Long — contraryinvestor @ 9:51 am



Political cartoonists, they are by definition the people who tell you which way the wind is blowing now and… are completely useless in making educated guesses about the future. (except as contrarian indicator)

Ford, who drives a Ford anymore? The tires fall off the cars, the back windows fall out. They over paid for Aston Martin, Jaguar and Land Rover and now they’re selling them off at bargain basement prices. Can this company get any worse?…. Wait a minute, can this company get any worse?

It wasn’t all that long ago that people were saying similar things about Boeing. Does anyone remember this, back around 2000? Boeing would never be able to compete with Airbus. Now its Airbus who is flying on life support. The simple fact of the matter is restructuring a company and getting it to perform relatively better isn’t really all that difficult. Shut down plants, fire people, dispose of under performing assets. Any MBA student could tell you to do these things. Granted, actually implementing these changes is more difficult. Particularly at a company the size of Ford. Turning around that company isn’t even as easy as steering the Titanic, its more like steering the iceberg.

Yet as CSFB noted in their July 27, 2007 research report: “Ford’s second quarter results were dramatically stronger than expected, with earnings per share at a positive $0.13, versus the Street consensus of a loss of $0.36, and our forecast of a loss of $0.26. Profits were better than expected in every operating region, with the most significant outperformance coming from North America, where the company reported a pretax loss of $279 million, versus our forecast loss of $850 million, and the consensus loss of greater than $1.0 billion.” Still CSFB rates Ford a “hold” along with every other analyst on the street, save 2. Personally I consider this a good thing, for one thing as Gordon Gekko said “..Analysts don’t know the difference between preferred stock and live stock.” The analysts will only come around to Ford once the stock has already begun to perform well again. As far as I’m concerned that’s too late for me to invest, I want to anticipate the turn around and already be in when it happens. Then as the analysts upgrade the stocks they will act as the wind at my back.

Signs abound of a major change in the US automotive industry. First off Cerberus Capital Management just bought Chrysler. Their ability to negotiate with the UAW will do a lot of Ford’s hard work for them. By wrangling concessions for the UAW Cerberus will make things easier for Ford to do the same. Further, Cerberus, Wilbur Ross and David Tepper are accumulating control stakes in major auto suppliers, most notably Cerberus and Appalosa are fighting over Delphi. As these aggressive players strip out the costs from the auto suppliers Ford stands to benefit from additional cost savings. The presence of all of these seasoned value investors in the auto sector tells me that I’m not mistaking a dinosaur for a value investment.

Simply put the Ford investment is a matter of sitting back and letting Ford finish its restructuring like IBM, Boeing, Apple, Coke and innumerous other turn around stories before them. This is a LONG TERM investment. Just to juice my returns, I’ll be buying the Ford Jan 2010 $10.0 Calls (FOAB). That’s it. I’ll read the news, the research and the K’s & Q’s but mostly I’ll put it under the mattress and wait for 2010. Ben Graham would be proud.

Chicks dig the long VOL

Filed under: Market Neutral,Sallie Mae — contraryinvestor @ 9:43 am


On April 16, 2007, Sallie Mae (SLM) announced that an investor group (“Investor Group”) led by J.C. Flowers & Co. (“J.C. Flowers”) signed a definitive agreement (“Merger Agreement”) to acquire the Company for approximately $25.3 billion or $60.00 per share of common stock. When the transaction is complete, J.C. Flowers and certain other private equity investors, including Friedman Fleischer & Lowe, will invest approximately $4.4 billion and own 50.2 percent, and Bank of America (NYSE: BAC) and JPMorgan Chase (NYSE: JPM) each will invest approximately $2.2 billion and each will own 24.9 percent. The remainder of the purchase price is anticipated to be funded by debt.

Any enterprising young man looks at the current share price of SLM and $46.90 and sees a $13.10 discount to the announced take over price of $60 a share of SLM and he say him self, “Free Money”. Yet, the Contrary Investor remembers his finance professor telling him something like “There’s no such thing as a free lunch”. Alas, the poking around of the new congress in regards to the excessive profit of the student loan industry as made Chris Flowers a bit less than enthusiastic about his trophy deal. The Senate and House voted to reduce education-loan subsidies by $18.3 to $19 billion during the next five years. Certainly this decreases the value of SLM to Chris Flowers by lets say $6.0bn ($19.0bn/5 (per year) discounted back at 20% (assumed general private equity fund hurdle rate) adjusted for cash taxes of $528mn on $1.07bn in pre-tax income for the first 6 months of 2007). However, Sallie Mae’s share holders certainly are not going to just hand this value over to J.C. Flowers. I really don’t think they have any incentive to do this deal at a lower price now that $60 has been set as the price. So the question Chris has to ask him self is if he is willing to give up his $25bn deal.

Personally, I don’t think J.C. Flowers is very likely to pack it in over legislation that hasn’t even passed yet. Certainly his old boss Hank Paulson (now secretary of the treasury) could help him lobby to lower this figure. Maybe J.C. Flowers really has the discipline to walk away from this deal. But they also have to ask them selves when they’ll be able finance another deal of this size. $25bn, though not the size of TXU, HCA or EOP, is still a HUGE deal and two years a go would have been unheard of. I have devised a formula to I call the Rain Maker Ego Ratio (patent pending) to calculate likely hood of Chris Flowers walking away from this monster deal. E (for Rain Maker Ego)=1 H (for fund manager Humility) = 0 C (Completion likely hood): E/H= C or 1/0=infinity *

So I therefore calculate an infinitely high likely hood that the deal will get done. Seriously though, it is far more likely that either the deal will get done at $60 per share original price or not done at all. If the deal doesn’t get done at all the shares should return to their April 12th pricing of $40.75, if not lower given SLM’s deteriorating fundamentals and the over all tumult in the credit markets. In oder to properly take advantage of these events I’ll be buying the $55 Jan 08 calls and the $40 Jan 08 puts. I’m long volatility in SLM shares, though I ultimately think the deal will get done…but maybe it won’t. Either way deal is due to close by October 2007 leaving time to deal with the January options. This technique is known as a strangle.


* I was advised by a friend to who is quant to calculate the implied vol for this strangle and then if the volatility I believed was appropriate was higher than the implied volatility then I should do the trade. This is sounded good enough on paper, but how exactly do you quantify the volatility associated with “Chris Flowers’ Ego” or the opportunity cost of having to wait an unknown number of years for them to do another $25bn deal. So alas I came up with my own formula (E/H=C), which I believe to be at least half as accurate as Black-Scholes. I’m hoping to receive my Nobel nomination any day now. I could be the next Bob Merton

“The combination of precise formulas with highly imprecise assumptions can be used to establish, or rather to justify, practically any value one wishes . . .Calculus . . . [gives] speculation the deceptive guise of investment.”
–Benjamin Graham, 1949

GS UPDATE (08/13/2007):

Filed under: Goldman,Short — contraryinvestor @ 6:46 am

I hate to say I told you so but, I told you so

That being said I’ll be holding off on my purchase of the puts until the volatility comes back in. The current pricing is a bit exorbitant.

GS Aug 07 3mo price chart2

August 13, 2007

BX UPDATE (08/13/2007):

Filed under: Blackstone,Short — contraryinvestor @ 11:35 pm

bear-attacks.jpg“Blackstone Group LP, manager of the world’s largest private-equity fund, said second-quarter earnings more than tripled as revenue increased during a record year for leveraged buyouts. Net income was $774 million compared with $224 million a year earlier, New York-based Blackstone said today in its first report as a public company. “

Wow earnings tripled… One would imagine on news like that a stellar name like Blackstone must have gone through the roof, right? But Blackstone rose only +0.43 (+1.70%) on the day, closing at $25.71. EARNINGS TRIPLED and shares only managed to move up 1.7%

August 10, 2007

Credit Crunch

Filed under: Goldman,Short — contraryinvestor @ 11:24 am

creditcrunch.jpg Sometimes the Contrary thing to do is to put aside your own general contrarian view and agree with general sentiment. The current tightening in the credit markets are invariably (OK not invariably, but probably) going to have an additional impact on the global equity markets. At present the S&P 500 is still up 2.5% year to date and despite all the “pain” some investors claim to be feeling, the markets have still not fully repriced the risk associated with excesses of the last two years of easy credit. The sub-prime lending of the corporate market, covenant-lite deals represented 17.9% of the levered loan market at the end of July, up from 10.8% at the end of the first quarter. The market will not be feeling indigestion from these loans for some time. While the repricing in the CLO/CDO market may have seemed sudden to hedge funds such as Sowood Capital the fact is that gobal default rates still stand at only 1.38% (a number that will invariably revert to the mean of around 3.2%). As the default rate and market volatility continue to increase stricter credit standards will lead to reduced money supply and likely economic contraction. In order to hedge the risk of my portfolio and profit from a likely market down turn I would normally short the S&P 500 (SPX) (though not the day after a 387 point drop).

However, with at beta 1.7 and two hedge funds which are currently takings losses (Goldman Sachs North American Equity Opportunities and Goldman Sachs Global Alpha) I chose instead to short Goldman Sachs (GS). Goldman will almost certainly weather the loses at its funds with out much impact to earnings. Yet, with Goldman being Goldman headlines about trouble at the world’s premier investment bank will inevitably multiply. As was seen with the trouble at the two Bear Stearns hedge funds that were liquidated last week, we can expect the negative publicity surrounding hedge fund troubles to weigh down GS shares. The hedge fund trouble at Goldman will only act as catalyst making this *trade* more appealing. Shorting Goldman becomes particularly of interest when one considers that despite the news of trouble at a second fund circulating Thursday GS traded down (on 08/09/07) only 5.72% in line with Morgan Stanley(-5.47%), Merrill Lynch (-4.46%) and less than Lehman Brothers (-7.15%).

While Goldman will certainly live fight another day the general economic conditions and potential negative headlines make Goldman a short. My instrument for this operation will be the Jan 2009 $140.0 puts (VSDMH). The 23% decline necessary to reach this strike price was achieved by Bear Sterns in less than a month after the announcement of its hedge fund woes. Mostly likely the performance of Goldman’s two funds will not be as bad as that of Bear Stearns. I will be using GS as a proxy for overall market performance, due to its high beta, and the hedge fund imbroglio can be taken as a bonus.

UPDATE (08/13/2007):

I hate to say I told you so but, I told you so

August 8, 2007

Thought of the day

Filed under: General — contraryinvestor @ 7:23 am


I am currently contemplating other investments, but since people do seem to be reading the blog I feel obliged to post something. My main concern as people begin trickle into the site is that anyone reading this site proceed with caution and with a long term investment horizon (3-5 years). In the cases where options are discussed the longest dated available options are by far the most prudent and where possible LEAPS are preferred.

And now… a thought on contrarian investing:

“There is a very important difference between being a theoretical contrarian and dealing with it in practical terms. In order to win as a contrarian, you need the right timing and you have to put on a position in the appropriate size. If you do it too small it’s not meaningful; if you do it too big, you can get wiped out if your timing is slightly off. The process requires courage, commitment, and an understanding of your own psychology”

Michael Steinhardt

August 7, 2007

BX the Dog

Filed under: Blackstone,Short — contraryinvestor @ 2:44 am

BX the dogIn today’s (08/06/2007) broad based rally in the financial sector every major investment bank and broker dealer was up tremendously. Fortress Investment Group, the other large publicly traded PE shop, was even up 6.67%, despite having sunk some 39.1% nearly straight down since its February 2007 IPO. They were all up that is, except BX.

While the average financial player advanced 3.51% BX only advanced a meager .57% despite BUY ratings from every major brokerage on Wall Street and a 281 point rally in the Dow. This behavior belies that there is little investor support for the BX “stock”. I use the term “stock” loosely to describe the BX non-voting units representing the limited partner interests that Schwartzman & Co shilled onto the market.
Yet another contrarian indicator appears on the first page of the BX OM: “We have entered into an agreement with an investment vehicle established by the People’s Republic of China … we will sell to it $3 billion of non-voting common units at a purchase price per common unit equal to 95.5% of the initial public offering price in this offering.”. Is there anyone who’s investment lead should be more avoided than government of COMMUNIST China. The country is literally anathema to making profit. Schwartzman saw these guys coming a mile away and their participation is just one more sell signal.

Taking a closer examination of exactly what one receives for his share in Schwartzman’s magical money machine uncovers the beauty of the Blackstone IPO (as a vehicle for cashing out the senior partners):

1)”The Blackstone Group L.P. is managed by our general partner, which is owned by our senior managing directors. Our common unitholders will have only limited voting rights and will have no right to elect our general partner or its directors.”
Translation: We’re in charge no matter how poorly we perform as managers or whether we decide to take your money and blow it on Beanie Babies

2) “Immediately following this offering, our existing owners will generally have sufficient voting power to determine the outcome of those few matters that may be submitted for a vote of our limited partners, including any attempt to remove our general partner”.
Translation: Don’t even think of trying to get rid of us, we already thought of that.

3) “The partnership agreement of The Blackstone Group L.P. limits the liability of, and reduces or eliminates the duties (including fiduciary duties) owed by, our general partner to our common unitholders and restricts the remedies available to common unitholders for actions that might otherwise constitute breaches of our general partner’s duties.”
Translation: We can and will screw you at our digression, and don’t think about suing over your rights as a Shareholder, you bought “units”… remember, units are not governed by the rules of fiduciary responsibility, “units” are governed by the rules which we have just made up… right now.

4) Potential conflicts of interest may arise among our general partner, its affiliates and us. Our general partner and its affiliates have limited fiduciary duties to us and our common unitholders, which may permit them to favor their own interests to the detriment of us and our common unitholders.
Translation: (See above section on unit holders being screwed)

I could go on but the general idea has become apparent. Blackstone’s unit holders have no rights. The OM does make mention cash disbursements to the unit holder which one must assume will be the only value of these “units”. While it is unclear as to the size of these disbursements at present, clearly BX’s $26.6bn market cap, a value nearly equal to that of Lehman Brothers ($30bn… and their share holders have rights) is far too high. As much as I am tempted to say these units are completely worthless the trade for my portfolio will be the purchase of the March 2008 $17.5 puts. While certainly unscientific, until the amount of the distribution is known, I will use the trajectory of Fortress Investment Group’s fall from $31 a share in February 2007 to $18.87 today as a proxy. A similar slide seems inevitable once BX’s underwriters are no longer vigorously supporting the price.

All of this being said, Blackstone remains an excellent business and a true leader of its field. The firm hires many of wall street’s best and brightest. However, one has ask to ask one’s self “Would Blackstone ever invest in the “units” of a company where it had no input on management decisions, no legal rights and management had not fudiciary obligation to protect Blackstone’s investment?” The answer is a simple, NO.


UPDATE (08/13/2007):

bear-attacks.jpg“Blackstone Group LP, manager of the world’s largest private-equity fund, said second-quarter earnings more than tripled as revenue increased during a record year for leveraged buyouts. Net income was $774 million compared with $224 million a year earlier, New York-based Blackstone said today in its first report as a public company. ”

Wow earnings tripled… One would imagine on news like that a stellar name like Blackstone must have gone through the roof, right? But Blackstone rose only +0.43 (+1.70%) on the day, closing at $25.71. EARNINGS TRIPLED and shares only managed to move up 1.7%.

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