Monday, 28 July 2008 01:00

The next step in my investment thesis

BoomBustBlogger Goatmug
has literally read my mind in a very recent comment, thus I have taken
the liberty to post his comment as an official blog post. This is what
I have had my team working on for the past few weeks. I would have had
some tangible results earlier, but the financial mess is more involved
than anyone could have guessed. That government put option assignment
didn't help any either. I would also like to thank all for the
supportive words regarding my effort with the blog. Don't worry, I will
continue to push out hardcore analysis. I can't guarantee it will
always be free, but I can guarantee it will be accessible to those who
appreciate its value and will be of value to those who share my values
and contrarian perspectives.

From Goatmug:

I just read this, some of Thain's comments regarding capital raising from a Reuters article.

By the way, that PNC trade looks good. I'm convinced $70 area is upper resistance (like steel). I was so disappointed to see that it came off of $69.50 where I bot more puts.

Third, I just want to remind everyone about how tight the credit markets are. I go to church with a CFO of a very successful oil and gas company, but they need to refinance debt. Credit is so tight that their best offer on the table for debt is 13%.... and this is a great company with awesome balance sheet and long track record. This is why I'm so convinced that the thesis of credit destruction based on the death spiral the banks are in is going to blow so many other companies up. Because banks are so wounded they are not lending, they are trying to fix their own balance sheet. This makes credit on "normal terms" for good asset intensive companies impossible to get. Without credit, the wheels of capitalism grind to a halt. The FED and Paulson are really noise as they keep yelling about liquidity rather fixing and allowing insolvency. The further actions of the Fed & Paulson lead to a crisis in confidence as investors around the world see the "free markets" become the "manipulated markets" and the exodus of capital has begun and will accelerate as money looks for better venues and better tax treatment without the "political risk". (Man, what a rant, I think that was more for me to layout my thoughts, but I hope it was helpful).

Also, on MER and taking the big hit, this could be the start of a very bloody weak. Remember, the first guy to puke this positions out and take the loss is ultimately going to have the highest mark b/c everyone else will need to run for the exits at any cost (unless you're like WFC where you'll just change your accounting practices and recategorize your defination of deliquent!!!

Thain's comments.

One of my first priorities at Merrill Lynch was to strengthen the firm's balance sheet, and today we have made great progress towards that by bolstering our capital position through these investments and our announced sale of Merrill Lynch Capital." (December 24, 2007 -- Thain in a statement when Merrill announced a $6.2 billion capital raising)

"...These transactions make certain that Merrill is well-capitalized." (January 15, 2008 -- Thain in a statement after selling $6.6 billion of preferred shares to a group that included Japanese and Kuwaiti investors)

"We're very confident that we have the capital base now that we need to go forward in 2008." (January 18, 2008 -- Thain as quoted by the New York Times).

"...Today I can say that we will not need additional funds. These problems are behind us. We will not return to the market." (March 8, 2008 -- Thain in an interview with France's Le Figaro newspaper)

"We have more capital than we need, so we can say to the market that we don't need more injections. We can confirm that we have tackled the problem." (March 16, 2008 -- Thain in an interview with Spain's El Pais newspaper)

"In 2007, we lost 8.6 billion dollars after tax, but we raised 12.8 billion dollars in new capital. We raised significantly more capital than we lost. And we did that on purpose so that we could say to the marketplace that we raised more than enough capital. We replaced all the capital we lost. We have plenty of capital going forward, and we don't need to come back into the equity market. The goal is to maintain our current ratings. No more capital raising; I'm sure we have enough capital." (April 4, 2008 -- Thain in an interview with Japan's Nihon Keizai Shimbun)

"We deliberately raised more capital than we lost last year ... we believe that will allow us to not have to go back to the equity market in the foreseeable future." (April 8, 2008 -- Thain to reporters in Tokyo, as reported by Reuters)

"John Thain has been very clear that we have sufficient capital and don't have a need to raise additional common equity for the foreseeable future. When we raised this capital in January, we had a lot of demand so we went beyond what we needed." (May 12, 2008 -- Merrill President Greg Fleming in an interview with the Times of London)

Having read all of this, I'm not sure I'd trust any of them if they say that this is the kitchen sink and they'll never need capital, what do you think?

Last modified on Monday, 28 July 2008 01:00


  • Comment Link Chris Marshall Thursday, 07 August 2008 04:21 posted by Chris Marshall

    Bloomberg, L.P. and Financial Data Services
    On July 17, 2008 the Company announced that it had completed the sale of its 20% ownership stake in
    Bloomberg, L.P. to Bloomberg Inc., for approximately $4.4 billion, and as part of this transaction had
    entered into a long-term service agreement. As consideration for the sale of its interest in Bloomberg L.P.,
    Merrill Lynch received notes issued by Bloomberg Inc. (the general partner and owner of substantially all
    of Bloomberg L.P.) with an aggregate face amount of approximately $4.3 billion and cash in the amount of
    approximately $110 million. The notes represent senior unsecured obligations of Bloomberg Inc. The notes
    consist of fixed-rate and floating-rate tranches and both tranches have maturities of 10 to 15 years. The
    notes accrue interest at market rates.

    Excerpt from page 68 of the recent MER 10Q

  • Comment Link Chris Marshall Wednesday, 06 August 2008 11:02 posted by Chris Marshall


    Have a look at the MER 10Q, they funded 98% of the $4.4B price of the Bloomberg holding, what sort of deal is that? I wonder if its non-recourse?

    It is no longer feasible for anybody to believe that they will not need to raise further capital, no wonder he went on TV BEFORE the 10Q was posted.

  • Comment Link Ed Ryan Thursday, 31 July 2008 01:48 posted by Ed Ryan

    Great post Reggie.

    The 'regulators' are allowing Enron accounting and ignoring SOX, the 'powers that be' are desparate and will do anything they can to keep the 'fiction' aflot untill the second Tuesday in November.

    For those in put options, make sure you are out untill January 2009. For the 'powers that be' are very creative in pulling a rabbit out of the hat.

    Will China intervine to keep the music playing?

    Deflation vs Inflation?

    Desperate people take desparate actions and care not for your possitions.

    We are in the mist of critical economic history and many books will be written 'after the fact'.

    God help the next president. I wonder if one should vote against the guy he likes to save him the pain.

  • Comment Link Arun Raja Wednesday, 30 July 2008 02:05 posted by Arun Raja

    Late night ... so I'll keep this short. You can do this yourself. If the underlying is 100 one day one, goes down 90 day 2, and comes up to 100 day 3, SKF will be 100 day 1, 120 day 2 and 93.33 day 3. So, even though the underlying did not change, SKF has already lost. Compound this over time, and you'll see as time stretches to infinity, the ultra funds tend to zero. This is why going short UYG makes sense over going long SKF. Check this graph.;range=2y;compare=skf;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;source=undefined
    Even though UYG and SKF started around the same pricing range, UYG has declined more than SKF has risen percentage wise.

    You have to weigh the dividend payout vs reward on the short side. I think as UYG tends

  • Comment Link Dominic Filion Wednesday, 30 July 2008 01:35 posted by Dominic Filion

    Doesn't UYG pay dividends that you will have to pay if you short UYG?

  • Comment Link Johnny Lay Wednesday, 30 July 2008 00:02 posted by Johnny Lay

    I have been thinking the same thing but could not prove it to myself. Mind sharing how u figured that out?

  • Comment Link Arun Raja Tuesday, 29 July 2008 23:39 posted by Arun Raja

    SKF and other 2x funds have negative alpha. A better way to utilize that to your advantage to short / buy puts on the 2x ultra long funds. Check SKF vs UYG and you'll see that UYG is a better play.

  • Comment Link Dominic Filion Tuesday, 29 July 2008 22:16 posted by Dominic Filion

    SKF is indeed a possible way to express what is seen here, though SKF does not specifically target the companies in the Doo Doo that are mentioned in this blog. Thus If you agree with Mr. Middleton and would like to put your money where your mouth is, SKF is still a crude weapon, though it's better than nothing.

  • Comment Link gabe krawzak Tuesday, 29 July 2008 19:51 posted by gabe krawzak

    I've seen a few boombusters mention the SKF...for those who are not familiar with the SKF or for those not comfortable shorting or using puts (or for those who would like more time than provided by options), the SKF is an ETF that is double short the DJ Financial Sector. Not meant to be a recommendation but I've utilized it a bit recently. is very volatile so please be careful. Thanks again Reggie for the continued analysis.

  • Comment Link Robert Maxi Tuesday, 29 July 2008 16:32 posted by Robert Maxi

    I'm currently holding a lot August puts on PNC, and seriously hoping this rally fizzles out soon. I've got a bad feeling that it could go sideways up here for a bit too long. Could use some reassurance.. so much insanity in the market. Hope everyone else is doing alright.

  • Comment Link Chris Marshall Tuesday, 29 July 2008 09:54 posted by Chris Marshall


    One last view on MER, I would have much preferred them write the assets down to zero ( as per National Australia Bank NAB). It would certainly put a bottom to their CDO exposure, and eventually they may even have write ups.

    Regarding the asset raising, $8.5B - $2.5B ( back to Temasek) - $4.7B to loan to the hedge fund to purchase the CDO's, = $1.8B. The issue price at $22.50 roughly 10% below current market price = a paper shareholder value loss of $3B approx, it doesn't look good, and it certainly won't be the last capital raising.

  • Comment Link Reggie Middleton Tuesday, 29 July 2008 09:50 posted by Reggie Middleton

    Look at where they are trading. In addition, since they didn't offload their risk, all they did was make things worse for the whole industry. They set the marks very low for GS, MS and LEH (obviously not low enough or it would have been a straight sale). Once the slower players catch on, the IB's books should be nearly chopped in half.

  • Comment Link Jason Bohmann Tuesday, 29 July 2008 09:42 posted by Jason Bohmann

    One last thing on MER...

    Yes, we know they sold assets off $30B or so. Yes, they sold it at 22 cents on the dollar.
    Yes, they financed 75% of the sale. Here's the nasty part,

    The buyer is only on the hook for $1.68B in losses from what I understand, so if there is a further deterioration of the portfolio, MER is still on the hook!!!
    From my perspective, this is simply just another off balance sheet hocus pocus attempt. Effectively isn't this what LEH did with the psuedo hedge fund with $7B in assets where the ex-employees were all high level guys that didn't terminate their retirement benefits and other packages????

  • Comment Link Chris Marshall Tuesday, 29 July 2008 01:59 posted by Chris Marshall


    Here are some thoughts on items found on company balance sheets etc.

    1) EBITDA - A facility whereby a corporation can take on as much debt as humanly possible, to make it look more attractive than its peers.

    2) Before Exceptional Items - This is how the figures would have looked, if we didn't screw up in a big way.

    3) Non-core Items - A facility designed to hide poorly performing divisions ( you can always move them back to core ops when they start to improve).

    4) Forward looking statements - A piece of fiction designed to make the shareholders feel good about owning the stock until the AGM is finished ( you can always issue profit warnings or downgrades later, when they're no longer looking).

    5) Forward P/E - a guess, based on an assumption, based on an estimate.

    6) Annual Report - 6 pages of useful info, 94 pages of rubbish, but an opportunity for the bozo's that run the company, to have their pictures and views aired.

  • Comment Link Reggie Middleton Tuesday, 29 July 2008 01:20 posted by Reggie Middleton

    Now all they have to do is make the loan non-recourse and allow PIK for debt service and I'll gladly by the assets off of them ;D

  • Comment Link Chris Marshall Tuesday, 29 July 2008 01:17 posted by Chris Marshall


    As you know I do not like Investment banks, as I cannot see how their corporate model will work without large amounts of derivative trading etc. However, it would appear that reality is finally arriving as to their finances, and hopefully all I banks will follow MER's example.

    The one point that I find galling is selling the debt at 22% of face, and then financing 75% of the transaction value, this is moronic and effectively its just playing for time, to rebuild its balance sheet and credibility.

  • Comment Link Kip Coon Tuesday, 29 July 2008 00:44 posted by Kip Coon


    PNC - as a full time trader, here is what I see. The recent high ($71.71) reached days ago is in fact a top resistance level (as you already know). Using linear regression settings, that top line on a daily view is set at $72.53 as the top range and $49.52 set at the low range. This is going back 1 year. The middle (mean or average) is about $61. Again, this is over a 1 year period. Also, on a 1 year, daily view, PNC recently hit it's 500 day moving average and resistance knocked it back down. PNC is headed towards it's 200 day moving average, which is $64.92. Not far below that is PNC's 1000 day MA at $64.16. Obviously a close beneath either of these two levels on some strength and volume will confirm PNC's downside move. RSI, MACD rolling.

    On a shorter 1 hr time frame, PNC has crossed below it's 20 and 50 day MA and sits in the middle of it's linear regression (think bell curve for anyone not knowing what linear regression is - stock price tends to move towards the middle) and standard deviation maximums at $78.83 and $57.65. The break on the 20 and 50, added to the recent trend are down. However be cautious of the potential for a very near term spike to the upside.

    SEC short protection is due to come off tomorrow. Considering the deterioration in the markets, it's possible the SEC extends the "naked short covering rule" it made illegal a while back. I would also consider further manipulation to extension of the rule monitoring to more stocks, if not all. As you mentioned, lot's of noise from the manipulators as nothing they do is working as they want it to. Funny how markets tend to fix themselves no matter what.

    I've had great success with PNC put positions. It's not always very liquid, so exercise caution in any large amounts of PUTs. I also went out an extra month or so on PNC in placing my PUTs. Currently, I have NO position in PNC, but I have studied it well.

    MER thoughts:
    I've been watching MER over the last week and each day I've told some others I share trading info with, that something is up at MER and it's not good. As they seem to show us the kitchen sink, I think this time it's a little more believable. Wow, never thought I'd say that. MER as we all know, is in Deep Doo-Doo! This is obvious by Thain's comments. MER is losing credibility fast with investors and Wall St. Not a good thing if you want to survive. This brings me to ....

    MER must really be bad off and has made the recent moves to stay afloat. This is just my opinion. They could not raise money through share offerings as that tactic was shown not to work at the time. The sale of Bloomberg, and the consideration of the Blackstone sale stunk of desperation. This recent move has me thinking they still needed more cash and were looking at every possibility to get it. My thought process is this was the only option left and they took what they could get.

    Tomorrow will be an interesting day. If MER is cleaning out the toxins, their worst may be starting to get behind them. Starting......... We've all seen the incredible rise after a BS earnings call and more than once for that matter. Chances are, we could see the same here. If the major toxin is out, less to worry about.

    MER took a ton of that crap onto their OWN books. At one time, the leader in doing so. MER wrote $28 billion in CDOs in the first half of 2007 alone. MER also took full advantage of leveraging and TRADING their OWN balance sheet with tons of risky, illiquid instruments. The more they knock off the balance sheet, the less trouble their in - as some may view this recent move.

    Yes, tomorrow should be interesting. Let's not forget that the Hedgies just had some of their worst months yet for losses. Large unwinding by the Hedgies will (if not already happening) have downward pressure on the market.

    The recent move by XL could be more of what's to come by the others. Bullish view by some? Could drive a short term rally?

    My own view is this market has MUCH more downside to come. Economic deterioration, tightened lending by banks, jobs being lost, we all know the issues.

    I don't tend to recommend people watch bubblevision, but in this case.... tomorrow morning 6 AM EST on CNBS... sorry.. CNBC Steven Hochberg is on. He's been calling the market levels near perfect all year. He writes a forecast 3x per week for Elliot Wave.

    Here is something for a little fun thinking...... What if this whole thing was/is orchestrated (but got out of control) to screw China since they hold many of our Dollars? Just a fun though, but interesting to think about it.


  • Comment Link Jason Bohmann Tuesday, 29 July 2008 00:25 posted by Jason Bohmann

    MuddlinThru -
    No, I think you are right on this. I haven't obtained an understanding of the covered bond deal and what that means for the banks. IF they can swap toxic for good and continue the shell game does it mean that there is now a much bigger tool available to hide assets? Does that buy them more time and MER's move is pre-mature so the rest of the financials hang in there?

    I think the MER thing is interesting too because they sold the stuff at 22 cents on the dollar, but then financed it too (75%).
    So, does the new covered bond fiasco give new license for ill or did MER & Thain just say the hell with it and take it all at once to distance themselves from the LEH treatment it looked like they were about to get? (see the action on them over the last 4 days or so).
    If I were Thain, I wouldn't want the continuing questions about solvency and counterparties pulling lines like LEH endured. I wouldn't be suprised to see a big drop at the open and then a big recovery tomorrow on the MER in particular, but the market as a whole.

    In fact, I'm planning on trading this and if there is a big drop... I'm out of all shorts to re-enter when the dust settles.

  • Comment Link Johnny Lay Monday, 28 July 2008 23:50 posted by Johnny Lay

    I have been reading about this since 5. I see lots of opinions that because of the way this deal is structured it wont result in marks. I certainly dont know but last I checked it does not seem to have effected the futures. Down 12 on Bloomberg of course their Asia screen appears broken.

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