WAMU Update

Position is still a little underwater but the expected earnings results were was as anticipated - mainly reflecting poor lending results and a large increase in negative amortization (interest added to loan balance but no cashed received) to $278 million out of $700 million earnings (approximate).

This is mainly a technical update. The stock has broken through the 10, 50, and 200 dmas on decent volume to the $42 area. I expect a retest of the support at $41 sometime in the following week. Then depending on market performance we need a Dow selloff to get the capitulation day were looking for - the stock could potentially trade as low as $36 where I would liquidate the position for a healthy profit.

Here is the longer term support and resistance points chart:






Here is the shorter-term break of the moving averages on volume as well as a recent distribution day highlighted in yellow as reflected by the volume indicator:

That is it for this week and a while. Have a great weekend and halloween. I will update again when we get a meaninful move in either direction or the positions expire.

Best regards,

BG

Shapin up to be a good day

Quite a few thoughts today - many of them off topic. First off - I have no class tonight which is a great break and will allow me to catch up on the research paper I need to finish for next week. Second - I want to recount something strange that I saw this morning at 7-11. Every morning I hit 7-11 for my coffee and breakfast biscuit. The price is right as even after the breakfast biscuit I am usually savings $1-3 vs. Starbucks. Anyways - this morning I ran into two heavy set women positioned in front of the nacho cheese machine at 8 AM in the morning. Now I can understand a hot dog in the morning (guilty as charged) - but these two had two grande bags of flaming hot cheetos OPEN. They each had forks and they poured nacho cheese to the brim of their bags and proceeded to mix it in with the flaming hot cheetos and devour it for breakfast. Atkins diet? I dont think so......If anyone has tried this or can relate - please comment - because this totally shocked me. Third - a client brought us two boxes of See candies today. :)

On the stock front I am down slightly on both positions (JPM and WM) and have so far avoided the knife on the earnings reports with both stocks trading down slightly. The market is in super bull mode however and it is tough to fight the trend. Still I don't think we can hold 12K on the Dow. I don't know well see.

I had some reader input today regarding a couple of the larger Dow Jones Transport Companies - Fedex and UPS. Mainly a comparative between the two from a fundamental perspective - which one is the better value, etc. I will discuss this a little bit but I think the bigger question here is not which is the better value but instead what section of the business cycle are we in? I think that we are in the last quarter of the expansion leading up to a recession - probably lasting at least 4 quarters. (Expected start date Q1- 2007)

Typically the transports get hit during a recession because there is less demand for products and shipping those products. Of course there are some other big factors affecting these stocks in addition to demand - such as fuel costs. I would expect to see a negative correlation between both USO (oil etf) and UPS or Fedex. I think that the following chart makes this evident:

Chart shows relative performance of DJ Transports Index v. USO (oil etf.) from September (start of oil selloff - forward)-



Oil will also fall in price during a recession so the improvement in margins may partially offset the slowdown in business. I think we have to assume though that we are at the top of the cycle for these stocks and the economy as a whole and that we can expect these stocks to perform poorly during a recession. I would rather buy these stocks at 52-week lows instead of the 52-week highs that they are at right now.

As a good analogy - some other readers showed interest in energy stocks only a few short months ago. Some significant interest was shown in Cameco (CCJ) a Uranium company. I offered similar advice back then as Cameco was at 52-week highs in the 40s. Now trading around 37 - you can chart it and try to pick it up closer to a cycle bottom (probably in the 20s). At the time energy was at a cyclical peak and the valuations reflected the strong business. Now that oil has sold off (potentially as an early indicator of slowing demand and economic growth) - these stocks are trading down as much as 25% from the former highs.

Bottom line is that when you are taking a position even with as long a time horizon as 2-3 years - the price you buy the stock at does matter. A difference in purchase price of even 10% can have a huge impact on 2-3 year compound returns.

If this is a lifetime holding (barring accounting fraud or some other bs) - then that is the one caveat. If you do all the fundamental research and come up with Fedex or UPS as the best bet and then swear to dollar cost average with dividend reinvestment plan running the entire time and by buying in EQUAL monthly, quarterly, yearly increments - then who cares where you start because over 20 years the costs will average out between good and bad times to give you an average cost basis and you can just liquidate when it hits a super bull cycle sometime in the enxt 10 - 20 years.

Still, I think the long term secular trend has to be huge for these companies. They are both the leading world shippers and with UPS' market cap around $80 billion and Fedex at $30 billion - both are large cap - but there is a still a lot of room for growth. When we consider China opportunities, globalization, and online shopping I would expect that these companies could some day grow to be megacap stocks in the $100-200 billion range. A long-term investment here could reap great rewards. Just remember the cyclical aspect though if it is more of a trade (even 1- 2 years would fall in this category).

If I took the 1-2 year holding period into context and was trying to come up with the best plan- how would I do it? Options. I know, I know - always options too leveraged and dangerous - but here I would pick the holding period - say two years and buy the 2009 call options - but deep deep in the money. For example - I would buy a 2009 call as far in the money as I could go and simultaneously sell an at the money put. This allows me to basically take on the position for 1/2 the cost and assuming the stock rises I can buy back the put at 50% or less of what I paid for it.

What if the stock goes down? Well.......assuming that this is still a stock I want - I should be excited about the drop in price and I can have the stock put to me on the at the money strike price (say Fedex is at $110 and I sell a $110 put option out to 2009 - I collect a $16 premium on the put which reduces my cost in the stock to $94).

The point is though that you still want to execute this strategy at the bottom of the cycle - not the top. That is where you maximize your return potential.

On a fundamental basis I think it will be more interesting to compare the two after the down cycle in business as well - we can see who whethered the storm the best. My gut here tells me Fedex as they handle most of the business related shipping (overnight letters, etc.) whereas it appears that UPS does more shipping of goods. Could be too superficial of an analysis - time will tell.

Best regards,

BG

Revisiting an old topic once again

It has been more than a year since I spent some time discussing analyzing and discussing the implications / impact of Telephone companies entering the cable tv arena with their fiber optic interenet and tv initiatives. Both Verizon and ATT consider this an important part of their strategy in the coming years as they can be a one stop shop for homes for all of the following services: mobile phone, long distance, local, cable tv, internet. Cable companies like Cox and Comcast are able to offer all of the above with the important exception of mobile phone. However, this may prove ironically to be the most important and impossible to acquire service at this point in the game.

Some important legislative developments in California and other states have been completed since the earlier discussion. If readers recall back in the good old days when Comcast or Cox wanted to offer cable television in a certain city they had to set up a meeting with the local government and sign a specific contract with that city. The contract had a set term and provided for both royalties and tax revenues for the local governments. This was a very costly and drawn out process. If Verizon and ATT were forced to endure the same process the barriers to entry would likely prove too large for them to get up and going in a state as large as California for many years.

So the Telecom companies decided to opt for an important shortcut. First they went to the FCC and requested specific legislation be enacted to grant them a Federal exemption to immediately offer service in any state they desired. When that measure failed they then began to approach each state directly. The largest state by population in the USA with more than 30 million people (California) recently approved a bill that effective January 1, 2007 will permit them to offer their cable services in any local city without going through the costly and time consuming negotiation process - cite - see SFGate article.

Now to the interesting business / accounting side of things. Comcast and Cox fought this legislation tooth and nail because their main competitive advantage was based on these formerly valuable "franchise rights" which they had acquired over so many years. In fact if we take a close look at the Comcast balance sheet we can see that it includes over $54 billion (thats right no typo) in "intangible assets." If we were to exclude these from the balance sheet Comcast would have a negative stockholders equity (accumulated deficit) of OVER $14 billion. Granted not ALL of the intangible assets have to be franchise rights (some could be other TV networks that were purchased or other internet related assets) - altthough any aquisitions would probably be included under the additional $14 BILLION in goodwill which is listed as an asset on the balance sheet. Here is a glance at the balance sheet:



This is getting brought up now because I noticed that Comcast common stock is up over 100% already this year to over $37 per share. See snapshot below:


So why else do I bring up apparently overvalued stocks? So that we can at some point in the game make money off of shorting them. I will bring this up later via the profit potential in some speculative LEAP PUT options (which happen to be ridiculously cheap).

Back to the analysis now - we need some sort of comparison. Who better than the leading competitor - ATT. ATT has also had some good price action this year - up more than 30% to $32+ per share. However unlike Comcast they appear to be in an admirable competitive as well as financial position.

Here are a few glances of ATT's financial position:


And a closer look at some important - balance sheet statistics of both:

ATT




Comcast


Now - based on the relatively low amounts of intangible assets on ATT's balance sheet I think that we can accept their book value and debt to equity ratios as reliable statistics. However, when we look at Comcast I think this book value number is grossly inflated and should probably be NEGATIVE. The debt to equity ratio would also be much higher - probably greater than 1! If we were to exclude the intangible assets.

Back to the point though - why are we looking so much at balance sheet and intangible assets - when the whole game is about earnings! Comcast has had good earnings growth and its PE multiple reflects that strength. The reason we are focusing on balance sheet is that the high PE which reflects a monopolistic market with high barriers to entry is going away and we can expect a lower PE more reflective of the coming price war.

If the value is going to get due only to PE compression (forget any earnings decline) then we have to ask ourselves about staying power? Which company can hold out and has the cash flow to beat the other ones. Both Verizon and ATT have their wireless businesses which are just dumping free cash flow into their hands - not to mention yellow pages businesses and local telephone business. They can use this strength to outspend and outperform Comcast and Cox which are heavily dependent on the cable TV as the core strength and driver of their earnings along with the internet.

To summarize:

Comcast advantages: Existing TV customer base (HUGE)
Comcast disadvantages: Leveraged balance sheet, removal of barriers to entry in main industry, no cellular phone service

ATT advantages: Superior TV/Internet technology (Fiberoptics), Mobile phone service, removals of barriers to entry in the tv industry, good balalance sheet and financial strength
ATT disadvantages: Few cable TV customers YET (a lot of other customers though)

Now that we have looked at some important fundamentals lets check out the PUT options on Comcast and see why the opportunity is so attractive.

If we look at the $45 2009 puts we can gain 5+ times leverage at a cost of less than 1%. This is unheard of for such longdated options and indicates a very low implied volatility level for these options.

I have not discussed timing yet - and I say might as well WAIT - do not jump the gun yet. Still this is an unfolding story that will be key to watch and presents some great paired trade options (Long VZ, ATT ; Short CMCSA, Cablevision, Charter)

I dont know what the end game will be yet - nobody does - but Comcast looks like a house of cards to me and would love to see some comments about what I am missing.

Best regards,

BG

Position, set, match

I received my final execution in Washington Mutual today and I ended up extending the time horizon an extra month to November 2006. This was more costly but the leverage is still astronomical - so I am not too concerned about the extension.

This is the final portfolio allocation as of today:

This will probably not be updated again until this winter. Any other posts would just be crying or bragging and are not useful to anyone. If the positions were to hit in a big way - maybe sending the portfolio up 100 or 200% it is possible that I would liquidate them and roll the money into another sector on the real estate spreadsheet that is not in the same phase of the decline.

I have a gut feeling that it will be possible to capitalize on the downdraft over a 2-3 year period, with the transactional players getting hit first (title, property insurance, banks, builders) and then followed by the players which are holding the systemic risk (re: fannie mae, freddie mac, bigger banks), and ending up with the REITS when the market values of property finally begin to decline in earnest and the NAV that has been the building block for the recent appreciation finally going out the window.

Hopefully we can make it to round 2.....

Best regards,

BG