Week-in-Review: Market and Chain Bridge Investing Highlights from the Week Ended 11-13-09
Welcome to the first Week-in-Review prepared and distributed by Chain Bridge Investing (“CB”). CB is currently working on increasing and improving this content. Expect additions and changes to the format and the content of the Week-in-Review for the next few weeks.
Chain Bridge Investing’s Brief Thoughts from the Prior Week’s Daily DLs
Investing at Current Market Levels & Timing of the Equity Markets
Many investors are doing their best to time this market and there isn’t anything wrong with such behavior. Yet, CB does not believe one should be “heavily” invested in stocks. It appears that many people are “heavily” invested in stocks and if there is a steep downturn, there is a chance that these investors will (1) not be able to adjust their portfolio to take advantage of the dip or protect against it; and (2) could lose their profits, especially if they are not able to quickly close out a position. If an investor believes the S&P 500 will reach 1200 before a potential downturn, then that is an additional 12% gain from the current market level. Is that gain worth being heavily invested? Especially if the investor has been invested since March. Investors should protect themselves from the sudden drop, which could occur before the Fed begins to indicate stimulus contraction. The extra 12% gain is not worth risking a loss on the majority of one’s capital.
Recovery & the Current Economic Situation
At the end of the day, this economic situation is scary due to the fact that it is unprecedented and the probability of this recovery being completed without hitch is very small. CB does not lack faith in the Fed or other central banks, but these officials are human and do not know what will happen as a result of their actions and those of others. They have an idea, but won’t know for certain until they are implemented in the real-life laboratory of the global economy. However, unlike an experiment or an economic model one cannot hold most variables as constant. Thus, it is highly unlikely that any plans to tighten monetary policy will proceed cleanly. Furthermore, one must factor in the effects of other economies on the U.S., and that implies that other central banks have to execute their recovery and tightening of monetary policy correctly. This situation would be different if most of the economies did not exhibit so many vulnerabilities, but they do. More vulnerabilities leads to increased probability of prolonged economic turmoil. Finally, if something does go wrong with the initial attempts to remove the extra money from the system, then does the government implement a short-term solution that only puts the economy in more long-term danger?
Gold & the Mining Industry
While many investors and traders believe that gold will continue to go higher, CB is not sure it can support the endorsement of the gold miners as investments. As Jim Rogers has stated, if you want to invest in gold, then invest in gold or an exchange traded fund (”ETF”) that tracks the performance of gold. Currently, CB’s data shows the price/earnings ratio for the gold and silver mining industry near 35.3 times, one of the highest ratios for all the industries. Meanwhile, this same mining industry is trading near a 36.7 time price/free cash flow ratio, which is also very high. Mining, as an industry, does not have consistent earning periods and usually witnesses very volatile operating results quarter-to-quarter. Furthermore, there haven’t been any new significant discoveries of gold in years – most of these companies’ mines are depleting. Will they benefit from the increased price of gold? Most likely, however, one needs to consider their operations and the potential for a sell-off.
For those questioning the gold rally, one should not doubt the psychological power of gold, since it has been desired and used as a store of value for over 5,000 years. That is a long history to fight against. The demand for gold is driven by of the fundamentals and psychology occurring throughout the entire economy. For instance, people move to gold when they fear the weakening of the U.S. dollar. Some claim that they move to gold in times of uncertainty, because if the confidence in the U.S. dollar breaks, then one can always rely on gold to be accepted. Oddly, gold, much like paper, is only considered money because society has come to accept it as money. With there being few industrial uses for gold, other than jewelry, people put their trust in gold just like they do paper money. Even when precious metals dominated currency, there was still monetary policy and inflation. In the Medieval to Renaissance periods, when a King needed more money for his kingdom, the purity of the metal in the coins would be diluted. As a result, the King could create additional money from the metals he already owned and thus inflate the economy. Whether paper or gold, the value of either is still based on their acceptance to others. Yet, the popular trust in gold, historically, does not appear to be a force one would want to bet against long-term.
The Shipping (Water Transportation) Industry
The shipping industry is capital intensive and heavily leveraged. During the most recent trade-driven boom, many new and old operators attempted to expand their fleets as well as their competitiveness by placing orders for new ships to be built. In the shipping industry, there is a preference for newer ships that are more effective during operations and are likely to be compliant with the changing operational and environmental regulations. With the surge of new shipbuilding activity, many of the shipping companies took on large amounts of debt, especially as prices and demand for new ships increased. As a result, many of those that overleveraged themselves now face the risk of bankruptcy and asset sales. This situation is a typical credit bubble. As stated in the article the pain has not been fully experienced yet. Several management teams that are looking at purchasing ships at discounted prices, believe the ships are being sold at good prices but aren’t at the great prices yet. Consequently, the better capitalized and operational shipping companies are waiting for more bankruptcies and more decreases in asset prices before enlarging their fleets. However, the reader should be aware that not all sectors of the shipping industry are feeling the impact of the downturn evenly. Some sectors, while they have a lot of new ships coming into the global market, also have relatively old fleets that are being retired as the new ships enter, thus partiality offsetting the effect of the new ships. Nevertheless, the shipping industry has been severely hammered by the market and continues to trade at industry averages of between 5 to 7 times price to earnings ratios. With the potential pending bankruptcies and distressed situations, the better capitalized companies should be able increase their operational asset base andl improve their financial results when the industry recovers, which may take three to 10 years depending on the sector of the industry.
Selected Mergers and Acquisitions from the Prior Week
11-13-09 Liberty Global agrees to acquire Unity Media GmbH for nearly $3 billion and the assumption of debt. Unity offers broadband Internet, telephone, and digital TV services to nearly 4.6 million customers in Germany.
11-12-09 British Airways PLC and Iberia Lineas de Espana have agreed to merge after more than 15 months of speculation. The combination will result in annual revenue of nearly $20 billion. Within five years after the deal closes, insiders estimate that the deal would increase profits by €400 million. Cost savings are expected to account for two-thirds of the increased profits, while additional revenue will account for remainder of profits. At present, the merged entity would rank seventh globally in traffic.
11-12-09 Hewlett Packard (“HP”) to acquire 3Com for $2.7 billion in cash ( a 39% premium) makes HP the top computer maker and the number two for networking gear, which is Cisco’s core business. HP intends to utilize its large sales force to increase global distribution of 3Com gear.
CB: One of the reasons that technology companies are considered by some to be risky investments is primarily due to the rapid change in products and market positions that can occur. For instance, HP is an excellent example of a company that was struggling in 2005 and four years later is now on top of the computer industry and has significantly expanded into new industries with positive results. In addition, until Cisco decided to publicly announce that it was entering HP’s product space within the last year, HP and Cisco were essentially long-term allies. For HP this acquisition is: (1) a step to further vertical integration and operational efficiencies; (2) an increase in both economies of scale and scope; (3) a defensive and offensive maneuver against Cisco; (4) access to 3Com’s already established Chinese network and a stake in China’s future growth; (5) an improved sales bundle for customers; and (6) a chance for HP to become stronger and take market share during a downturn where many companies are not aggressively expanding. A move like this was probably foreseen by those close to the industry, especially as Cisco continued to use its war chest to acquire many different companies over the last several months. There are many investors like certain Tiger Fund managers that believe HP is a great company and a great investment. CB has not analyzed HP in depth for a while now, but has observed that the company was very resilient during the down turn and was able to rely on its operational efficiencies to minimize the negative impact to profits. Since HP is a large company, it has the ability to play with accounts and operations in various divisions, thus it can better tailor its results to Wall Street expectations.
11-12-09 United Technologies (“UTX”) agreed to acquire General Electric’s fire-and-security operation for $1.82 billion. The acquisitions will not have an impact on UTX’s earnings until 2011 and is expected to improve UTX’s position as a major player in the $100 billion fire-and-security industry.
11-10-09 Logitech International SA announced that it would acquire LifeSize Communications (“LifeSize”) for $405 million in cash will likely close in December. LifeSize is a manufacturer of video-conferencing equipment and will enhance Logitech’s presence in the video conferencing market, which is estimated to be a $2.1 billion market with expected growth of 15%. LifeSize expects revenue to be approximately $90 million in 2009 and expects revenue to grow between 40% to 60% in 2010.
11-9-09 Sonova Holding AG (“Sonova”) announced that it would acquire Advanced Bionics Corp. (“Bionics”) for $489 million in cash will likely close in December. At present, Bionics has a 18% market share in the cochlear implants market. The deal allows Sonova to offer another product with very little overlap to its customers with hearing problems.
11-9-09 Northrop Grumman has agreed to sell its TASC consulting unit to General Atlantic LLC and Kohlberg Kravis Roberts & Co. for $1.65 billion. Private equity firms have increased their interest in defense engineering and consulting practices like TASC due to the government’s increased interest on outsourcing defense services. Meanwhile, Northrop Grumman expect to receive approximately $1.1 billion and will use the consideration for share buy backs.
11-9-09 Electronic Arts (“EA”) has agreed to acquire Playfish, an online-gaming company, for at least $275 million. EA’s purchase represents its attempt to establish a presence in the still small but growing social gaming arena.
CB: In the early spring of this year, many analysts and investors made remarks on the strength of the video game industry and its ability to resist the downturn. Some assigned credit to the industry’s historic ability to resist a downturn, while others cited the Wii’s appeal to the causal gamer for this feat. However, a few people concluded that the gaming industry would not evade the effects of the downturn in 2009 when considering: (1) the weak line up of games in 2009, compared to last year; (2) the saturation point of Wii consoles; (3) the decreasing quality of Wii games, or essentially the Atari effect; (4) the fact that the major crisis occurred towards the end of the year and did not have ample opportunity to show its force on the gaming industry; and (5) this downturn was much worst than the last two. This became more obvious throughout the year as large titles scheduled for release before year end, continued to be delayed until calendar year 2010. Nevertheless, EA’s current situation is a result of: (1) the industry headwinds mentioned above; (2) its overlapping-operational bureaucracy; and (3) its inability to limit its focus to a few core and very profitable franchises. Basically, EA has much household cleaning to conduct if it wants to substantially improve its bottom line.
11-9-09 Google has agreed to acquire AdMob Inc. for $750 million in stocks. AdMob is estimated to have between $45 million to $60 million in annual revenue and is one of the largest mobile-advertising providers. This purchase is an attempt by Google to extend its large Internet advertising empire to mobile phones.
CB: At the time of this transaction, Google’s stock price was at a 52-week high, CB would not be surprised to see Google deploy more of its stock for acquisitions, especially if the company’s management believes the stock to be expensive.
Significant Insider Transactions from the Prior Week
11-12-09 Dan L. Duncan Chairman & 10% Owner bought $4.9 million of stock. Enterprise Products Partners, L.P. (“EPD”)
11-12-09 Michael P. Connors CEO, Chairman, & 10% Owner bought $999,998.69 of stock for Information Services Group, Inc. (“III”)
11-12-09 David E. Berger CFO bought $396,250.00 of stock for Information Services Group, Inc. (“III”)
11-12-09 James A. Milton CEO & President bought $245,280.00 of SoundBite Communications (“SDBT”)
11-12-09 Thomas M. Ryan CEO & President bought $509,320 of stock for CVS Caremark Corp. (“CVS”)
11-11-09 Stanford L. Kurland CEO & Chairman bought $259,500 of stock in the Pennymac Mortgage Trust (“PMT”)
11-10-09 Terrance H. Gregg CEO & President bought $101,513.20 of stock in DexCom Inc. (“DXCM”)
11-09-09 Lynn L. Elsenhans CEO & President bought $282,500.00 of stock in Sunoco Inc. (“SUN”)
11-09-09 Joel A. Ronning CEO bought $5,005,200.00 of stock in Digital River (“DRIV”)
More to Read
How to Ignore the Yes-Man in Your Head – The Wall Street Journal
Basically, when analyzing stock investments, investors tend to spend more time looking for information that confirms their theories – rather than seeking information that could prove them wrong. Investors should always look for scenarios that prove their investment selections wrong.
Arrogant Fed Hasn’t Learn a Thing – Bill Fleckenstein
Based on Mr. Mishkin’s comments in the Financial Times earlier in the week, Mr. Fleckenstein doesn’t believe the Fed has learned much about the nature of bubbles and the need to prevent their future occurrence. Furthermore, Mr. Mishkin believes that the only bubbles that are necessary to fear are those that driven by credit, ignoring the important side effects of a bubble driven by irrational exuberance.
Key Oil Figures were Distored by U.S., Pressure, says Whistleblower – Guardian
According to an International Energy Agency (“IEA”) insider, the IEA has: (1) inflated the estimates of oil reserves and (2) inflated the production rate of oil. Currently, the IEA has stated that in 2030 the world will be able to produce 120 million barrels a day, but many inside the IEA believe that even production of 90 million to 95 million barrels a day would be difficult to sustain. Yet, the IEA has apparently manipulated this information to prevent extreme rises in the price of oil.
Tagged with Gold, Insider Trades, Investing, Mergers & Acquisitions, Shippinh, U.S. Dollar
