Can Turtles Fly?

One of the risk arbitrage plays that I have mentioned before is BCE of Canada (BCE; TSX: BCE). BCE is the largest telecom in Canada and it is being taken over by a consortium. The payment is in cash and is supposed to close early next year. Fabrice Taylor of The Globe and Mail has written a good column summarizing the details and the risks. Note that everything mentioned is in Canadian dollars. BCE also trades on NYSE. f all goes well, BCE shareholders will get their money some time in the first quarter of 2008. Let's assume the last day of the quarter, March 31, to be conservative. The offer is $42.75 a share while the stock is quoted today at $39.20. The four-month return, then, is a little more than 9 per cent - and even more if investors get a dividend before the deal closes. As the author suggests, you are looking at around 9% in 3 or 4 months. This is a low-risk arbitrage situation so that's a good return. If you are an American and are bearish on the US$ (I am not) then...

Well, anyone considering investing in Ambac (or others) should definitely look at the bear case. Reggie Middleton provides a super-bearish case saying that "Ambac is effectively insolvent". Take a look and form your own opinion. I haven't read it yet so I don't have anything to say. For what it's worth, he is short Ambac and MBIA. Some people might think somone's report is nothing more than propaganda in light of that but I generally think the opposite. If anyone is putting their own money on their calls, I respect that... The problem with Ambac for both shorts and longs is that this story may not end for at least 1 year. Some people think that the market will take a stand one way or another after the rating agencies release their rating evaluations but I suspect not. Every bad news is going to push the stock down and the occasional good news, along with short-covering, will push the price up. The stock has been moving almost 5% on a daily basis over the last...

The FCC, which is moving at a snail-like pace, indicated today that they will try to have a vote on the Tribune (TRB) acquisition by the end of Friday. The stock is still nowhere near the acquisition price of $34. If the FCC waiver is granted by Friday, the last remaining step is for the bankers to raise money for the deal. On another note, I have noticed that the spreads on takeovers have widened again. Almost sure-bets like BCE (BCE; TSX: BCE) have dropped recently. Other bids worth monitoring are Clear Channel (CCU) and Credit First Boston (CBH). I haven't evaluated any of them deeply (except when I mentioned BCE in some posts several months ago) so none of these are concrete ideas. If I recall, all these deals close next year so if you like the prospects then you need to be willing to tie up your capital until next year. Given that December sometimes involves heavy tax-loss selling, it may be more attractive to buy beaten-down stocks instead of going for merger arbitrage deals...

Bill Ackman supposedly thinks that MBIA and Ambac will be bankrupt by mid 2008 if they can't raise capital: Bond insurer MBIA Inc could be insolvent as soon as the second quarter of 2008 if it were unable to access additional capital, according to a slide at a presentation by Pershing Square's William Ackman. Ackman estimates MBIA will incur $2.2 billion of losses in the fourth quarter, and rival bond insurer Ambac Financial Group Inc will incur $4.2 billion of losses . Nothing new from Bill Ackman, who has been bearish on the bond insurers since 2003 (based on some article I read back then (I think in Forbes). Since I'm bullish (although not bullish enough to take a position right now), this makes me uneasy. If he were not a so-called value investor, I would sort of brush it off but since he is a value investor (meaning he is likely basing his views on bottom-up approach*), it is something one should consider. I really want to get my head around where he is wrong. He has ...

AccruedInterest posted a breakdown of the loss estimates that was used for Ambac in the prior blog entry. The author goes on describe the situation facing Ambac and others when it comes to raising capital. As I remarked in my prior post, reinsurance is the least dilutive but it will hit future earnings and I would guess that it will shave 2% to 3% off future ROE. But if a lot of capital needs to be raised then multiple methods may be needed, including issuing shares (the most expensive of all). The tricky thing for those sitting on the sidelines is that we don't know how much dilution the market is pricing in (the knowledgeable experts may but newbies like me don't). My strategy, assuming my risk arbitrage position on TRB is closed successfully, is to wait until late December and see what the rating agencies say. You can try to outguess them by buying before their decision but that is very risky.

Birinyi Associate's TickerSense posted the chart below showing stock market returns throughout the world (thanks to SeekingAlpha for the original reference): (source: TickerSense, Birinyi Associates) If you visit their site, you'll get a table showing the returns for individual countries. The top 5, in order, are China (135.18%), Ukraine (121.20%), Bangladesh (90.83%; who says poor countries suffering a crisis don't do well? ;) ), Romania (76.15%), and Slovenia (74.59%). The bottom 5 are Ireland (-29.89%), Venezuela (-28.04%), Estonia (-14.41%), Japan (-12.14%), and Ecuador (-9.79%). You can tell from the map that developed countries (USA, most of Europe, Japan) are posting negative returns, while the dark green areas with hig returns are high growth emerging markets. The middle green varies but you can easily tell that commodity countries are dominant. What this map says--to me--is that the developed countries are slowing (none have entered a recession or posted less than...

Ambac says that they will consider using more reinsurance in the future: Ambac CFO Sean Leonard said the company will continue to defend its triple A rating, and added that there's a lot of opportunity for the company to reinsure its transactions. He said about 85 percent of the company's portfolio is non-mortgage related. Go to Ambac's homepage to check out the presentation at the Bank of America conference. A PDF presentation can be found here . Well, the presentation is biased in favour of the bull case (what else is to be expected from management?) The strategies that Ambac will use to meet capital requirements are supposedly: In order of preference: Reinsure block of current book Increase reinsurance on future business Alter mix of business to less capital-intensive transactions Debt or soft capital issuance – approximately $600 million of capacity Equity issuance (source: Banc of America Bond Insurance Mini Conference Presentation , November 27 2007) It looks like t...

I was wondering what S&P was doing all this time but they finally initiated a review of the bond insurers . Recall that Fitch and Moody's have already initiated their review and are supposed to release their thoughts within the next month (timing is just an estimate). According to what Fitch was saying a few weeks ago when they started their review, Amabac has a moderate probability of their AAA rating being under threat, while MBIA had a low probability. There is a huge gap in the equity analysts covering the bond insurers, not to mention the bloggers and other small investors like us. I only have access to the free analyst reports from my discount brokers so my analyst knowledge is limited. Morningstar thinks that the market is overreacting on Ambac (as well as other insurers). Based on the article referenced above, Citigroup analyst thinks the same: Citi Investment Research analyst Heather L. Hunt expects the AAA ratings on Ambac, MBIA and Assured Guarantly Ltd. to be reaffi...

Not too sure about this one but I'm wondering whether I should take a risk arbitrage position in Restoration Hardware (RSTO). A management-led private equity buyout is in the works for $6.70 (deal expected to close in March 2008). The company has said it will solicit other offers until December 13th. It looks like Sears Holdings (SHLD), led by value investor Eddie Lampert, is thinking of bidding for the company . Speculation is that RSTO will be a good strategic fit for SHLD so a higher bid may come. The shares are currently trading around $7, which is about 5% more than the original offer by the private equity group. The problem for anyone taking a position now is that no new offer may come from SHLD. Sears has bought up almost 14% of RSTO's shares so even if they don't offer anything, they will profit from the original bid; whereas if you buy the stock now, you will end up with a 5% loss. The motives of Sears isn't clear. The strategic fit argument would have a lot m...

( UPDATE : added a minor comment and fixed the market cap (should be $250m not $25m) ( UPDATE 2 (Sat@9:39 PM) : I found out accidentally that bigcharts does have a log graph, so I updated the chart with a log graph) I'm adding Suruga (TSE: 1880) Corporation from Japan to the watch list. I looked at this a while ago when I saw the P/E ratio of around 4 but it turned out to be a mistake due to a stock split. I was thinking of researching Japanese small cap retail, food, and real estate companies (anything to take advantage of strengthening Yen and a possible resurgence in consumption. I came across this again and saw that it has sold off quite a bit since early this year--practically the whole Japanese small cap area is down quite a bit (it might be one of the cheapest on the whole planet). Just to quickly re-cap, Suruga is in the real estate sector. The whole real estate sector has been doing well over the last few years and Suruga is no exception. The question is whether it can kee...

General Thoughts on Japan As I have remarked many times before, I am planning to focus my future investment research on Japan. Until I do more reading, I won't know for sure but right now it fits my profile and strategy. It is out of favour (can you believe it is actually negative for the year in US$ terms?), transparent (easy to get information for the large companies, and corporate governance is improving), relatively low valuations (on a P/E basis it is not cheap but if you think earnings are depressed then it isn't so bad; on price/book it is pretty attractive), etc. Not sure when I'll get to it but my goal is to read these two books in the near future: Japan on the Upswing , and Japanese Money Tree . Anyway, here are some articles I read on Japan recently (some of these articles are old and I only read them now)... Barron's had this run down of the attractiveness of Japan. I liked the article but my thesis for investing in Japan is to avoid the 'China play...

Accrued Interest has just posted an analysis of Ambac's potential losses . The news isn't good for Ambac shareholders. The final conclusion is that Ambac needs capital injection of around $2 billion to $3 billion. If you are interested in Ambac (or other monolines), you should read the full post at that blog rather than my selective quotation. First let's consider what AMBAC needs to do to retain a AAA rating. All three of the major ratings agencies have a similar methodology for bond insurers. They need to survive a Great Depression-type scenario. The agencies then estimate how much capital an insurer would need to survive such a scenario. As long as the agencies has capital above this minimum, they get their rating. Currently AMBAC has between $1.1 billion and $1.9 billion in "excess" capital over what's needed to retain a AAA/Aaa rating, depending on the agency. That's sort of what Ambac needs from a rating agency point of view... Regardless, I think th...

CIFG, a bond insurer from France, just raised some capital in order to stave off a rating downgrade. It remains to be seen what happens to Ambac (ABK). A few weeks ago Fitch indicated that there is a moderate possibility of Ambac's rating being under threat (for reference, the smaller ones that are trying to raise capital have a high probability of losing their rating). It'll be interesting to see how the market reacts to any of this. The problem for companies like Ambac is that raising capital during a crisis, like now, is very expensive.

Canada's national newspaper, The Globe & Mail, has launched an investing magazine called Globe Investor. It seems to be tailored for Canadian investors and seems useful. The inaugural magazine cover story is an interview with Bill Miller . As I have remarked before, Bill Miller is an amazing investor because he is one of the few value investors who can analyze technology stocks properly. Here is some of the Q&A that I found interesting: Q: Buffett or Graham would never dream of Google or Amazon.com at these kind of price-to-earnings ratios. A: Actually, I disagree with that a little bit. Graham, in congressional testimony in the '50s, was asked about what he looks for when buying a stock and he said, well, stock prices depend on future earnings. And so, to the extent that one could actually make the judgment about future earnings, one would be able to know which prices were attractive. There's two reasons Buffett doesn't buy [tech stocks]. Number one, he believ...

Municipal Bond Buyers Still Using Bond Insurance According to Joe Mysak of Bloomberg.com , the market is still receptive to bonds insured by the monolines. At a time when nobody really knows if the nation's major bond insurers will still be rated AAA in a couple of months, municipalities are lining up to get their bonds insured. Investors, evidently, are buying them. Last week, more than half of the issuers who sold bonds got their deals insured. This is exactly the proportion of bonds that are normally insured during a given year, at least recently. This means that the primary business of most monolines, which is to insure municipal bonds, is still functioning. One of the concerns for any monoline investor is whether sales will decline due to customer anxiety over their viability. According to this article, things are still looking good. If I were to invest in Ambac (ABK), one of the things I would want to be certain with is that customers don't avoid the market. Some bears cl...

Paul Krugman, who has been bearish the US$ for ages, is of the opinion that it isn't so bad. He makes an entry in his blog about this. The US economy is going to suffer from housing, but apart from that, I also share some of Paul Krugman's views. I don't see how a weak US$ is bad for USA per se. The weak US$ should reduce the current account deficit, by increasing exports and weakening imports. We have actually seen this for the last year or so, with current account deficit declining. All throughout the 90's, the Canadian dollar declined quite a bit yet the economy was doing well. I think USA will end up in a similar situation. This is one reason that, although I'm bullish on Japan, I am not too sold on their exporters. The market is bearish on Japan (in fact the Nikkei is the worst performing major index, with negative returns this year) but those that do like Japanese stocks tend to favour the exporters like Toyota, Sony, Nintendo, and so forth. If the Yen carry ...

Swiss Re just reported a 1.2 billion CHF (swiss franc) mark-to-market loss on their credit products. This is important because Swiss Re is an insurance company so their losses may be more similar to what monolines face. Anyone looking to invest in monolines should take note of potential losses (but read my comment below questioning whether they are similar to monoline contracts). According to their presentation on the losses , here are some bullet points: Transactions are structured as CDS protection on MBS portfolio managed by third party First was written in 2006, second in 2007 Originally structured to attach at super senior level, with risk of loss considered remote Underlyings are MBS, both CMBS and RMBS (in prime, midprime and subprime form) and CDOs Their losses are from the CDS protection they wrote. It is not clear to me whether these CDS transactions are similar to what CDS transactions monolines write. The presentation mentions that their monoline division doesn't see a...

If you are not familiar with the current situation regarding bond insurers and want a quick article that summarizes the present situation, check out this overview by bloomberg.com . I think this news article pretty much sums up the Street's view. Reggie Middleton in his blog presents the bearish case for the bond insurers (LOL dig his humourous diagrams). He uses Bill Ackman's presentation to make his points on why MBIA is going to zero. He calculates that a 104 bps (basis points) change in CDO spread wil wipe out MBIA's capital. I'm not really sure how he calculates that so I can't really comment much. One thing to realize about going into these monolines is that you are going up against Bill Ackman of Pershing Square. I don't know much about him but he seems to be a value investor with a good track record (something like 27% annual return for many years). Bill seems like a smart investor and I have to think about where he is wrong and why. All I know is that ...

Really... do we need bond insurers? That's the question being asked by many, the latest being Joe Mysak at Bloomberg . With the chaos in the bond insurance market, this is a good question to ponder if one is thinking of investing in the bond insurers. After all, one shouldn't invest in something that has no viable business plan and is actually worth zero. Joe Mysak goes on to comment about what has been happening in the bond markets lately. The municipal market hasn't worried about this situation. I took a look at last week's negotiated and competitive bond sales calendars to see if the current whirlwind surrounding the insurers has made a dent in their ability to win business, at least in the municipal market... Of the 150 transactions on the negotiated calendar last week, 68 carried insurance. That's more than 45 percent of the number of deals. During the same week last year, 71 of the 149 negotiated deals were insured -- almost 48 percent. A handful of these were...

UPDATE: Ambac has posted some answers to frequently asked question in their FAQ section. It covers quite a bit about the nature of the risk at Ambac. For some reason the disclaimer button doesn't work in Firefox but it seems to be ok on Internet Explorer. UPDATE 2: AccruedInterest has another great post , this time touching on how defaults in RMBS and CDOs impact insurers. The author is supposedly working on his analysis of Ambac and I look forward to checking it out. Anyone looking to invest in monolines should read the post. Michael in a post to my prior blog entry on Ambac mentioned that the intrinsic value of Ambac (and others) will drop to zero if their ratings are cut. I sort of disagree on the possibility (read my response) but the rating cut is very important to consider. I thought I would show some diagrams of the capital adequacy according to Moody's and Fitch. Note that the diagrams below are dated (I think it was Fitch who said that some of these hypothetical c...

A poster by the name of jckhoury at gurufocus.com has posted an investment review of Ambac (ABK) . He/she provides an overview of the situation and comes up with some estimates of the intrinsic value of Ambac. The author's optimistic scenario results in a price of $83.74, while the pessimistic case ends up being $15.75. Note that the pessimistic case results in a price below the current stock price. If you are thinking of Ambac or one of its competitors like MBIA, it's worth reading as many opinions as you can so do check out the article. In my opinion, the real issue with Ambac is pinning its risk to some dollar figure. The valuation seems pretty attractive under most scenarios but the risk of some serious adverse result is highly uncertain. Any success or failure with Ambac will come from correct determination of its risk.

Here are some random thoughts running through my head... Housing Stuff There is a lengthy 5-page article on Countrywide Financial (CFC) at New York Times. I glanced at it and it runs over the history of CFC and some of what happened in the lending industry recently. Pretty good article for anyone that is thinking of investing in CFC or learning about what the lenders were doing in the last couple of years. One of the big risks for anyone like me dumb enough ;) to consider investing in debt insurers is the chaos that may be unleashed if some mortgage insurers fail. I am still working through my examination of Ambac (ABK) and it seems that it should survive, but I am not so sure about the smaller companies that insure mortgages. News articles like this makes me think that there could be further sell-offs in the debt insurers if one or more of the mortgage insurers collapse. Although value investors generally don't try to time stuff, I'm not a value investor and I don't want...

I have been reading up on monoline insurers (i.e. debt insurers) recently. I just received Ambac's investor package in the mail yesterday (I like reading the printed stuff, although it might out of date to some extent) and will be working through that. Hopefully I'll have enough understanding to make a final decision by December. I'm planning to put a huge chunk of my portfolio into Ambac (ABK) some time in December or January. If someone is attracted to this industry and wants a lower risk profile, they should consider MBIA (MBI) instead of Ambac (ABK). Ambac's CDO exposure is much higher than anyone else out there (but that also means its stock price is down much further). Articles/Thoughts on Debt Insurers If you want some history of the monoline insurance, check out this document . I also ran across this technical article on the industry . The document is really talking about something else but the first few pages are quite useful (I haven't read it yet). This a...

(update: added presentation by Pershing Square at the bottom) Well, it has certainly been a wild ride for monoline insurers lately. I'm not sure how shareholders of Ambac and other monlines are coping these days. Here are some happenings in the world of Ambac... Conference Call I'm not sure where to start but Ambac management will be holding a conference call on Wednesday. The call is supposed to shed some light on CDOs and how the mark-to-market process impacts Ambac. I believe this is a prudent move by management to clarify the situation. There is certainly a lot of rumours swirling around. I'm not an expert but I think a lot of people are making the mistake by looking at these monolines as if they were a typical investment bank or hedge fund. In particular, a lot of people just seem to take the outstanding par value and divide it by the capital and end up with some ridiculously scary number. There is between $1 trillion and $3 trillion of debt that is insured by all the...

Quick housing update... Not a surprise to anyone but Beazer (BZH) eliminated its dividend and cut 25% of its workforce . Beazer Homes USA Inc., the home builder that has been rocked an investigation into its mortgage-origination business in addition to the housing pullback, has suspended its quarterly dividend in an effort to firm up its capital position... Last month, the builder said it found evidence that workers in its mortgage business violated Housing and Urban Development regulations. Its probe also uncovered evidence of other accounting irregularities that will lead to expected restatements, Beazer said. On Tuesday, Beazer said it was unable to report its fourth-quarter and fiscal 2007 results but was providing preliminary, unaudited data. It has negotiated waivers of default from its lenders due to its failure to report financial results on time... Beazer said it let go about 650 workers, or 25% of its staff, during October. As you can see, Beazer has a whole hoard of problems...

Financial Times covers the logjam at the FCC over the Tribune (TRB) deal . As is the case with anything to do with politics, nothing is ever rational and one can never be sure what is going on in the backroom. Tribune has warned the FCC that the takeover is at risk of collapsing if it does not receive regulatory clearance in the next two weeks. But Kevin Martin, the Republican chairman of the commission, in private conversations, has said he is unwilling to address the matter before December 18, the date he has set for a vote on industry-wide changes to media ownership rules. Putting it off until mid-December seems to be a political strategy: Instead, in a move that some say reflects Mr Martin's reputation for being a calculating political operator, the commission chairman is pressing forward the broader media ownership overhaul. People close to the FCC say they believe Mr Martin is holding up the Tribune deal for political reasons. The transaction has won the backing of a handful ...

I read a very good analyst report from HSBC ( When will the homebuilding bust end? by Ian Morris and Ryan Wang, HSBC (Nov 2 2007)) where they try to shed some light on when we might hit the bottom of housing. Every single Wall Street analyst has been guessing and been wrong for over an year (recall the somewhat infamous calls in late 2006 for the bottom, which turned out to be completely wrong!) The analysts identify 4 prior housing corrections where residential construction has declined for 4 or more quarters. The prior 4 construction declines were in 1966, 1973, 1981, and 1990. They look at a bunch of different metrics, ranging from unemployment rate, to GDP contribution from housing, to % of gross domestic demand, among others. Using these metrics, they compared the current correction to the prior ones and tried to determine when we might see the bottom. Perhaps the most bearish way of looking at it is if you look at housing share as a percent of GDP. Using this metric, HSBC estima...