Monday, August 16, 2010

So you think you are a contrarian?

Under-appreciated statistics on contrarians

1) 98% of contrarians at the Pamplona "running of the bulls" get run-over
2) 98% of people view themselves as having a unique and insightful opinions, when in fact it was simply derived from another commentator (i.e- Fox news, network media, blogs)

That being said, we here at are ready to boldly assert we are considering a true "contrarian" play. Namely, we are looking at several stocks in the disgusting for-profit education sector. Congress is concerned about education quality and rapid-growth of for-profit schools, which tend to leech off of federal student loan programs. In particular, our efforts are focused on the least-liked names in the least-liked sector of the market:

1. COCO- Corinthian Colleges: $5.23 last trade, valued at 1/3rd of TTM sales, 1.9x Ebitda, or 3.2x earnings . The stock is down 75% since April 2010 (past 4 months) and trades at a market capitalization of $460Mln.

Ironically, COCO paid nearly $400Mln cash to acquire a higher-quality college chain (Heald) in 2010. Had they saved their money, they would be trading at/near their cash position on the balance sheet. The entire value of COCO appears to be comprised of Heald College and the 17% of revenue derived from Canada. There appears to be little value placed on the bulk of COCO's principal business unit "Everest College". Most of COCO's revenue comes from vocational programs (auto tech, etc) or 2-year associates degrees.

Washington Post owns 9% of COCO stock and my belief is this company is likely to receive a private-equity or third-party bid for the company. It is difficult to estimate what impact government efforts to limit Federal student loans will have, but I do not believe it will destroy this company (although it could cause sales/earnings to take a hit).

2. WPO- Washington Post: $318 last trade, valued at .48x sales, 2.9x ebitda, 10x earnings. WaPo is down 44% from its April peak ($2.3Bln enterprise value), following a Barron's analysis that WaPo "is the most undervalued stock in the entire media sector". If the statement was remotely true in April, then it is even more so today!

Interestingly, WaPo generates earnings from multiple segments outside of for-profit education. It owns a number of cable-tv monopolies that generated nearly $300Mln Ebitda, which at a 7x multiple= $2.1Bln valuation. The company also owns its namesake newspaper and broadcast tv stations which are worth between $500Mln-$1Bln. On top of this, it had more than $1Bln cash on its balance sheet ($600Mln net of debt outstanding).

Essentially, WaPo is trading at a 13% discount to fair value, entirely ignoring the value of its Kaplan education division ($2.3Bln enterprise value vs. $2.6Bln estimated value of non-education businesses). So, any valuation assigned to WaPo's education segment is "gravy", as some might say. Considering that the education segment generated $377mln EBITDA over the past twelve months, it is clearly WORTH SOMETHING, even if its business activity is viewed in a low-light. If we assign a distressed EBITDA multiple of 2-3x, that segment should be valued between $750-1.1Bln.

So, combining our $2.6Bln base-line value for non-education segments of WaPo with our $750Mln base-line value for WaPo's Kaplan segment, our estimate of enterprise value increases to $3.35Bln. This valuation equates to $507 per share and represents 60% upside to the current stock price. Warren Buffett owns nearly 20% of WaPo, although its unclear if he has any interest in buying more.

Key potential catalysts that drive our "contrarian" spirit:
1) Stocks are significantly oversold within a very short time-frame

2) Both businesses have segments that are "high-quality" or immune from proposed federal legislation on "gainful employment", as it pertains to eligibility to issue Title IV student loans.

3) The value of the higher-quality, "immune" businesses exceeds the current market valuation on COCO/WPO stock

4) Federal legislation on gainful employment will not occur until AFTER upcoming 2010 congressional elections. If Democrats lose control of Congress, I believe odds of current legislation being passed decrease significantly.

5)As currently written, the new student-loan requirements are specifically designed to exclude poor, highly levered minorities. In particular, the bill will effectively shut-out those minorities with low-paying jobs and difficulty with reading/higher math. Curiously, Democrats want to spend hundreds of billions putting subprime borrowers into homes, but now want to curtail loans designed to educate those same subprime borrowers (giving them a shot at higher-paying jobs)?

6) One other potential catalyst is that for-profit schools underwrite their own loans and become a hybrid teacher/student-loan company. Interest rates would have to rise, defaults would be problematic, but in such a scenario the core business survives

7) Costs at for-profit schools rise less than non-profits. Most non-profits are focused on expanding their campuses and building giant altars to the football-gods (massive stadiums) or their own hubris. As such, for-profit schools will be better able to manage flat/negative growth in tuition rates than non-profits.

8) It is unlikely that any politician passes a bill that bankrupts the for-profit schools overnight. Take Corinthian as an example. Their student enrollment is currently 110,000 students. They have been around since 1995, which means more than 1,000,000 students would have worthless degrees thanks to a legislative effort by Congress. How will an out-of-work constituent feel to re-write their work resume' and remove their education credentials? How would that make them vote?

Tuesday, August 10, 2010

Feds yell "bomb" inside a crowded savings account...

Lets use an analogy: since the US Federal Reserve is the policeman for our monetary system, we will compare their actions to policing a theater. Their stated goal is to maintain stability (prices), while maximizing the number of people watching movies in the theater (full employment). Under normal circumstances, movie patrons are courteous, polite, and anxious to get inside and watch high-quality theater fare (i.e-such as "Black Dynamite").

But what happens when there is a slowdown and cinematic-poo like "Macgruber" is showing on the main screen?

People may still show up at the theater on Friday night wanting to see a movie, but would be unwilling to sit down and suffer the 90 minutes of pain called "Macgruber the Movie". While patrons may choose to wait quietly in the lobby for a better movie to start up, this is not politically or economically viable for our "theater police". The regulatory mandate is to maximize employment (people watching the movie, regardless of what is showing). As such, watching and waiting for a better movie or story to come along is not acceptable.

So, our "theater police" (Federal Reserve) spring into action... first they cut the price of movie tickets by half (lower interest rates). But what if people still choose not want to watch the current "movie" (i.e- spend money, shop, buy houses, consume)?

Well, what if the theater police used their power to scare patrons, with the following threat: "Go inside and watch the current movie, or we will make sure you can never see a movie again!".
If the threat is perceived as real, many patrons would reluctantly go watch the film, no matter how bad. Does the outcome justify the means? Are such strong-arm tactics appropriate for regulators/authority to use? Does shattering any sense of stability to to achieve full employment make any sense at all?

This is at the crux of recent economic silliness (some would mischaracterize it as "debate"). Most recently, one of the Federal Reserve Board governors (James Bullard, St Louis) noted that the massive and unprecedented expansion of US money supply (trillions, with a T) has not caused economic activity to increase significantly. Bullard goes onto suggest that an appropriate course of action would be for the Federal Reserve to scare the populace by printing even more money (under the term "quantatitive easing"). Bullard's logic is that causing individuals to panic-spend their life savings (because they are scared of their government debasing the currency) is preferential to slow economic growth.

Going back to our theater analogy, we now have someone in authority suggesting that it would be appropriate to yell "Bomb" in the lobby of a crowded theater, under the auspices that it might make some people run further into the theater (perhaps accidentally into where the movie is being shown). The problem is that some people will run out of the theater altogether and never come back (avoid US$ currency exposure), while the individuals inside the theater will be panic-stricken about when the bomb is set to go off. The inadvertent horror of watching MacGruber the Movie will become the least of their worries!. Alas, that leaves us with a careless regulator that has witnessed the carnage and tries to undo the damage by saying, "Just kidding, I was not going to blow the place up".

Such thinking is not bourne of responsible, intellectual leadership. No, not even for the purpose of "evoking a debate". If you yell bomb on an airplane, you are arrested. End of story. If our Federal Reserve Governors yell "bomb" with respect to the savings of the average American, do they expect it to generate productive, long-term investment?

Lest you think the dissertation above is hypothetical, I have attached a link to an utterly embarrassing research paper posted by an irresponsible member of the Fed Board of Governors, James Bullard.

PS- Why do central bank decisions matter?

Your savings(if denominated in US$) are directly managed by our US central bankers at the Federal Reserve. Although hypothetically controlled by our Treasury Department, the Fed which actually controls the amount of currency in circulation. For example, while it may have taken you twenty or thirty years to accrue a fixed-income pension, a small social-security-stipend, and perhaps a modest sum in your bank account..... our central bankers can conjure up a similar sum within a millisecond.

In truth, our central bankers can conjure up many multiples of our country's net worth within a few milliseconds, thanks to the wonders of computers and electronics (no more waiting for an outdated printing press to crank out all those bills by hand!).

So why does this matter? Well, your "savings" only have value to the extent that a purveyor of physical goods/services(i.e- grocery store, Best Buy, etc.) has demand for your currency. If our central bank doubles the supply of currency in circulation overnight, the value of your currency is debased (cut in half). It may take awhile for most people to recognize this. If you are earning minimum-wage working at a bowling alley, you will continue to earn your minimum wage....but that person has taken a significant pay-cut relative to his real cost of living. Unless the minimum wage worker has significant real-estate holdings or hard-assets (i.e- gold) lying around, such currency manipulation harms his interests. It harms the citizenry as a whole.

Tuesday, August 03, 2010

Logic=Fail by Top Economists (Part Deux)

Another example of absurd reasoning by the economists that drive our monetary policy and influence our political leaders:Nobel-Prize winning economist Paul Krugman, of the New York Times and Obama confidant

Krugman has criticized both Bush and Obama for "not doing enough" to either 1) Avoid a massive depression or 2) Create a magical economic recovery filled with jobs and growth in GDP (Gross Domestic Product- a broad measure of economic activity) .

First of all, we ARE NOT IN A DEPRESSION. It seems scare tactics are a key ingredient to creating headlines and generating an unnecesary response from politicians/central bankers. GDP for 2009 was $14.2 Trillion, near an all-time high and up approximately 1% from 2007. Thus, in spite of the massive housing and credit collapse in our country, our economy continues to hum along near its all-time high. Consumer prices and company profit margins remain high and deflation is virtually non-existent outside of technology/housing.

Second, a recovery in jobs that is driven by the government increasing its own payroll does not create productivity or sustainable economic value in the long run.In spite of our "GDP data" appearing strong, many people are unemployed as a significant number of unproductive jobs were shed from the system. Many of these jobs were associated with unnecessary car production, mortgage financing, realtors, construction, leisure, gambling, etc. So if many private-sector jobs disappeared, how has our economic data remained strong?

Answer- Massive increases in government spending. Since 9/11, our government spending has increased at a rabid pace, only more-so since the housing bubble reached an unsustainable size.Currently, the government is nearly 40% of our economy.

So our economy only appears stable because of the excessive government spending (Lesson of the day- When people spend more than they earn, its called going into "hock". When governments spend more than they earn from taxes, its called "stimulus"). So our federal government is akin to someone that has lost his job, but wants to feel good about himself by pulling out the credit card and treating himself to a few fun foreign wars (Iraq/Afghanistan), unnecessary new tech(defense) gadgets, and extra perks (massive increases in transfer/social payments).

Curiously, many cities and states are reporting massive deficits, in large part because of the high pension benefits guaranteed to their many workers. The suckle of permanent government employment ensures that budgets cannot be right-sized in a downturn, to the extent that the private sector rationalizes its profit/loss. Yet, economists suggest that the correct course of action is for the government to further increase its spending role in the economy?

How much government is too much? 50% of our economy? 60%? Once the government hires workers and subsidizes poor investments (i.e- our housing bubble in the 2000's), it typically has a long and ugly end. For markets such as Detroit, which have seen a massive exodus of people, it is equally difficult to tear-down excess housing stock as it is to fire highly-paid municipal workers. In fact, one of the drivers behind Detroit's decision to bulldoze thousands of homes was the high cost of employing unionized police/fire workers to protect their communities.

Logic=Fail on part of Top Economists

A prime logic failure of many "economists" today is the circular reasoning that is employed. For many so-called Keynesians, if the economy is weak, its the responsibility of the government to "stimulate" it. It must not be left alone for a second! If the economy continues to weaken post-"stimulus", economists will confidently state the problem, " You did not use enough stimulus!" Upon firmly applying 20x the amount of "stimulus", the Keynesian economist would not second-guess the stimulus issue at all.

Although economics has claimed to be a science, it seems to rest entirely on theory and very little on empirical outcomes (see last post for other examples).

-In the real world, excessive use of antibiotics in hospital patients can lead to resistant bacterial strains ("super bacteria"). As such, if antibiotics are not having the desired effect, intelligent doctors will seek alternate treatment methods or prescriptions.

-In the real world, when you throw water on a grease fire and it simply spreads the fire further, a fireman will not tell you to throw more water on the grease. He will suggest a different course of action.

-In the real world, when a little child discovers that his square peg will not fit through a round hole, he plays around until he finds the right peg for the right hole

None of these empirical realities towards problem-solving is utilized by so-called "economists"
. Which begs the question, if economists have no benchmark to determine when their monetary experiment has failed, how will they know when to shut it down?

Economists- Argumentum Ad Absurdum

Peter Lynch is a wise man and correct about many things. One of my favorite quotes from him is that "If you spend more than 13 minutes analyzing economic and market forecasts, you've wasted 10 minutes". This was never more true than today, when it seems neither amateurs or professionals are adding much value to the debate.

Silliness is widespread. For example, statements from our President that "we will lose 3 million jobs if we do not pass a stimulus bill". Then, after the stimulus is passed and we still lose MORE THAN 4 million+ jobs, a new study is engineered to show that the stimulus worked better than expected, even though the outcome is below the worst-case, no-stimulus forecast.

Keynesianism (a.k.a-government stimulus as savior in all circumstances) is truly a circular argument with no way of igniting any logical/factual debate. A great example of simple logic failute by the economist-elite is seen below:

Economists Tell the Masses: "It Could Have Been Worse"
Monday 02 August 2010

by: Dean Baker,

"the economists are back telling us that we should be thankful that Congress and the Fed enacted the TARP and the other programs that saved Goldman Sachs, Citigroup, and the rest from bankruptcy. A new study by Princeton University Professor Alan Blinder and Mark Zandi, the chief economist at Moody's Analytics, examined the impact of the TARP and the related Fed and FDIC bailout programs. The study found that without the bailout, GDP would have declined by another 6.5 percent and the economy would have lost another 8.5 million jobs. In other words, things might be bad now, but if we didn't shovel trillions in loans and loan guarantees to Goldman Sachs and the rest of the Wall Street gang, they would be even worse.

Before we start thanking Goldman for taking our money, it is worth taking a closer look at the study. The big story here is the counterfactual. What does the study assume the Fed and Treasury would have done if we had not passed the TARP and the Fed had not come through with its vast array of emergency loan and loan guarantee programs?
The answer is that the study assumes that they would have done nothing. In other words, the question asked by the study is "what would the world look like if the federal government had done absolutely nothing to counter the economic and financial downturn resulting from collapse of the housing bubble?"

This counterfactual seems more than a bit unrealistic. Suppose we had let the market work its magic and put Goldman, Citigroup, Bank of America, and Morgan Stanley into bankruptcy. Suppose that once these firms were in receivership and their bank units were in the hands of the FDIC, the Fed flooded the system with liquidity. How would this situation compare with the situation where trillions of taxpayer dollars were put at the discretion of Goldman and the rest through TARP and the Fed's special facilities?

The Blinder-Zandi study tells us absolutely nothing about this scenario. In other words, Blinder and Zandi have constructed an absurdly unrealistic counterfactual and told us that the TARP was much better than this absurd scenario. This is like saying that people who don't eat chicken will starve to death. Under the counterfactual that people who don't chicken don't eat anything else either, they certainly will starve to death.

But that is not a serious analysis of the benefits of eating chicken, and Blinder and Zandi have not given us a serious analysis of the benefits of the TARP. This "it could have been worse" line should be flushed down the toilet. The reality is that greed and incompetence created an entirely unnecessary disaster. Tens of millions of people are still suffering from its consequences. And the Wall Street boys and the economists who are responsible for the disaster are all doing just fine.
People should be really angry about this and a silly study that might be used to tell them otherwise should just make them angrier.