Thursday, 19 March 2009 00:00

Cash Shortage in the Flim Flam Scam?

Shaunsnoll posed an interesting question in the comment section of the last Flim, Flam Scam article and I want to address it as its own post so I can include exhibits and charts. Shaun asked,

"Reggie, in your previous analysis you said this company has "38% or $22.4M of the total debt outstanding accure in less than one year" when i look through the financials though its not clear to me exactly when that debt will come due. it seems like with 26M$ in cash currently, this 22.4M$ debt coming due could really be what breaks this company, so would be good to know when exactly that is coming due.

PS: it just blows my mind everytime i see this stock rally....."

Well, Shaun, sharp rallies such as the one we just had are opportunities for the dispassionate fundamental investor. Price and value have significantly diverged in terms of this company and significant opportunity is at hand. Let me walk you through it a I see it.

The following table was derived from page 5 of my forensic analysis:

Year Share buyback Average price Total amount (US$) Most recent close Gain/(loss) per share Net average shareholder gain/(loss)
2004 1,453,318 $ 25.71 $ 37,358,071.00 $ 30.89 $5.18 $7,528,187
2005 457,362 $ 35.04 $ 16,025,809.00 $ 30.89 ($4.15) ($1,898,052)
2006 1959487 $ 37.47 $ 73,422,956.00 $ 30.89 ($6.58) ($12,893,424)
2007 1,318,724 $ 50.40 $ 66,457,372.00 $ 30.89 ($19.51) ($25,728,305)
2008 1,053,614 $ 42.44 $ 44,718,000.00 $ 30.89 ($11.55) ($12,169,242)
Total/Average 6,242,505 $ 38.12 $ 237,982,208.00 $30.89 ($7.23) ($45,133,311)

As you can see, the share buyback program is literally gutting the shareholder, thus far to the tune of nearly $33 million. Wealth destruction on a grand level, at least percentage wise. Wait, there's more...

Insider Sales of Stock (US$)
2004 $532,079
2005 $2,620,030
2006 $34,066,205
2007 $10,818,727
2008 $14,121,708
2009 as of Feb 17 $6,714,000
$68,872,749

A large portion of PPD shares were held by the board of directors and the management of the company which, apparently, incentivized the management to continue to buyback shares at higher prices and negative rates of return, producing significant benefit to themselves. I really do mean significant benefit at the expense of shareholders. Management has netted over $68 million from the sale of the stock into the corporate buyback program. This is over 150% of the shareholder wealth destroyed by the share buyback program! PPD used the money collected as membership fees from those who lack the analytical skills to determine what was going on for the purpose of overpriced share buybacks. From 2004 onwards, PPD has utilized US$237.98 million for share repurchase, out of which a full 28.9% (nearly 1/3rd) has gone directly to the insiders while the shareholders are getting burned by overpaying for the privilege of enriching the management and the board. In addition, the rate of insider sales this year has eclipsed that of all previous years since 2004! It appears as if management has come to the same conclusion that Reggie has reached - basically, the "Jig is Up!". Securities regulators, where art thou???!!! The Flim Flam Scam! I have made this very simple for any regulator to follow through. This begs to be investigated. If you are a shareholder of this company and continue to hold those shares after reading my research (which I have made available for free as a public service, see my subscription rates), I believe you to be a fool and you know the saying, "A fool and his money are soon to be parted". If you are short the company, remember, save your money and do something charitable with the profits. The monies were made by shorting a company which literally fleeced others who didn't know any better. Give back! It's the right thing to do. If you are a regulator and you ignore what you have read here, you are doing a disservice to your country. These may be strong, or unpopular statements, but hey, its how I feel and its from the heart!

I have even more stuff to make you love this company, for I haven't even addressed Shaunsnoll's question yet. Now, Shaun, they ended 2008 (last quarter) with roughly $26.528 million in cash. Look on page 37 of their annual report (the debt due line is highlighted in yellow: pdf PPD annual_report_2008 20/03/2009,02:51 749.07 Kb) and you will find contractual purchase obligations of $26.6 million due within one year. Of those obligations, $22.408 million is long term debt due. This would be a problem even if their business was humming along smoothly, which we all know it is not. So, you see, even without being a Ponzi scheme (which I feel they are) or a pyramid scheme (which I feel they are as well), they are probably going to implode for fundamental reasons. Of course, it would be sweet justice if they imploded for being a Flim Flam Scam, but hey, we should take whatever we can get.

More on my earlier takes on Prepaid Legal Services if you are new to this conversation:

My free summary on PPD: pdf PrePaid Legal Services Actionable Intelligence Report - Pro 2009-03-14 06:51:32 675.65 Kb.

I have decided to make it free as a consumer service, thus to that end I will release the Professional Forensic Analysis as well (this one time). Enjoy: pdf Prepaid Legal Services Forensic Analysis - Pro 2009-03-19 14:20:00 288.45 Kb . This latest report is from the perspectice of an investor or shareholder while the previous report was a summary intelligence note, suitable for a broader audience, ex. regulators, politicians, etc. I obviously believe this is a no-brainer short proposition, but there is risk entailed so reader beware. There has been a bit of research, or shall I say whistle blowing, in regards to this company. It would be a shame if it were to all be ignored. For your entertainment, here is additional commentary and research from:

A refresh of my recent REIT analysis should be about within 24 to 36 hours, with special addendums for Pro susbscribers.

Last modified on Thursday, 19 March 2009 00:00

52 comments

  • Comment Link thecreature Thursday, 26 March 2009 04:31 posted by thecreature

    Haha, apparently owning 7% of PPD didn't slow James Simons down too much... can someone please just give him a call? :D

    FT - "Renaissance emerges as top hedge fund manager"
    James Simons, the founder of New York-based Renaissance Technologies, was the top earning hedge fund manager last year, earning $2.5bn in spite of the extreme market volatility, as his 20-year-old flagship fund generated a net return of 80 per cent.

    http://www.ft.com/cms/s/0/3b519a38-18cb-11de-bec8-0000779fd2ac.html

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  • Comment Link Reggie Middleton Tuesday, 24 March 2009 01:29 posted by Reggie Middleton

    I agree that we will probably have some real number manipulation which will make the banks look like they are earning more than they economically are. This will be a very volatile and risk period, long or short, but as I see it the fundamentals of the short thesis have not changed as of yet. The government intervention as provided the added stimulus for this neck breaking rally, but I warned of this about two weeks ago and it shouldn't be much of a surprise. I will be posting my macro opinions over the next few hours (after daybreak, that is) to convey my thoughts on the matter.

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  • Comment Link greenja1 Monday, 23 March 2009 14:27 posted by greenja1

    Interesting supposition here. Fundamentally banks are screwed, but this could be short-term poison.....

    Actually, Banks Could Be Very Profitable In Q1 (C)
    Joe Weisenthal|Mar. 20, 2009, 2:41 PM|13

    There's been deep skepticism over whether banks like Citigroup (C) and others should be believed when they say they're profitable again. An industry insider forwarded us the following back-of-the envelope analysis to explain that yes, in fact, the major banks may be quite profitable in Q1. The key lies in the government's effort to push down their cost of capital.
    --------
    When Lloyd Blankfein says he will be profitable, few people are surprised.  When Jamie Dimon casual mentions that JP Morgan is going to have a great year, the market barely reacts.  But when Vikram Pandit and Ken Lewis make similar statements about profitability, the bears howled in disbelief and the bulls used the occasion as the foundation for a 10 day market rally.

    Skeptical myself, I began to investigate how such a claim could be made, knowing full well that the price of making the claim without it ultimately being true would be a complete loss of any credibility still remaining at these institutions.  What I found is astonishing and worth thinking about carefully for those still short the financials (or the markets in general).

    Financial Accounting Standards Board, the governing body on all things accounting, issued FAS 157 “Fair Value Measurements” to become effective for entities with fiscal years beginning after November 15, 2007.  Banks must use the methodologies outlined in this statement to value their assets thereafter.

    The statement separates assets into three groups, called Level I, II or III assets.  Level I assets are stocks and other highly liquid assets for which valuation doesn’t warrant significant discussion.  Level II assets are allowed some degree of freedom based on market inputs but the hard to value assets are pushed into the Level III bucket.

    With Level III assets, for which there is no market, the owner is allowed broad discretion in marking the assets to market.  The favored methodology is a discounted cash flow analysis whereby the holder would estimate future cash flows from the asset and apply a discount rate to calculate the present value of the future payments.  This discount rate is central in understanding why banks will indeed be profitable in 2009.

    While the banks were operating using private capital, their cost of capital was likely in the 4% to 6% range.  With the Federal Reserve driving rates down to near zero and providing, along with the Treasury, access to debt capital with very low interest rates, the cost of capital at this institution has come down considerably.  Recall that most of these programs were started late in the banks Q4 reporting period and we have not had a full three months operating under the rates.  Let us look at a simple example of what happens to the value of a 30 year interest only (IO) mortgage paying 6% when the holder’s discount rate changes from 6% to 3%.

    Value at 6%: $100.00

    Value at 3%: $158.80

    So in our scenario, which doesn’t assume any impairment of the asset, the bank would realize a gain of $58.80 on the asset simply from a change in its cost of capital.  While it would, eventually, realize this over time if the mortgage performed and its cost of funding remained the same over thirty years, the statement would allow a bank to recognize the gain immediately.  This is, albeit, a simplistic example and the ultimate calculation would be more nuanced but you can see where this is headed.

    With all the low cost funding provided by the Federal Reserve and Treasury, surely the banks will be profitable this year.  It doesn’t take a lot to make even a distressed loan look profitable if you tweak a few assumptions.

    The problem comes when the mortgage holder stops making payments and the bank has foreclose and sell on the house.  Now instead of a nice revenue stream to discount, the bank has a real asset that has a value that is less fungible and reality will set in.

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  • Comment Link phirang Monday, 23 March 2009 08:21 posted by phirang

    see ya'll at 950.

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  • Comment Link duanef Monday, 23 March 2009 07:10 posted by duanef

    hmmm... we'll have to disagree on this one. My strategy will be to set an alert for PPD at 50 and if and when that happens I will take a look at it and see if maybe it isn't time. This company can easily ooze along for long enough to ride out some relatively short term Puts, which as you point out, there ain't no Leaps out there. I agree that Netflix marketing strategy is different, and you and I may think it more respectable, but that doesn't mean NFLX doesn't lose more members every year, as a percentage of total membership, than PPD. It's part of doing business. The key that would make the analysis of PPD more compelling would be if the service itself was a scam. e.g. you signed up but then you couldn't get a lawyer consult. But I've seen no evidence that that is the case, have you?



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  • Comment Link Reggie Middleton Monday, 23 March 2009 02:16 posted by Reggie Middleton

    @Badger, the biggest difference is that I take profits when available, at least that has been the biggest difference to date. The second biggest difference is that I concentrate where I feel I have the most opportunity, and that is probably tied with (and into) adding to my position if/when it goes against me.

    This will eventually cause a nasty drawdown that I will never get back if I don't accurately anticipate when things will get better. Being aware of this, I keep my nose to the ground and I regularly take cash profits so as to lock high gains in throughout the year.

    @Phirang,
    That is a plausible and enlightening diagram, but it is still speculation until you know the exact plans of the TALF. Even if the TALF does come through too favorable for the banks and onerous for the tax payer, Congress and the Senate can (and probably will) weigh in. The 90% tax on bonuses is the writing on the wall. Many tout it as a smoke screen to hide the fact that AIG is being used to pump an extra $150 billion into the banks, which I agree with, but many are also missing the fact that lawmakers are repairing the one larges flaw in Wall Street since the big partnerships went public. That flaw is the uneconomical compensation system that still rewards execs and big revenue generators as if they were partners but leaves the shareholders holding the economic risk of an operating company as their profits are distributed to faux partners.

    There is no way in hell Wall Street would have done this voluntarily, and there is no way they would have allowed this to happen if they were in control, which they are obviously not.

    Many would rather see their firms go down and the culture of overpayment remain intact than the other way around, since they could always go back into the ashes of the old firm via the pheonix effect or through a new firm and resume excessive pay.

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  • Comment Link phirang Sunday, 22 March 2009 23:34 posted by phirang

    reggie, under TALF 2.0, we get the following:


    http://1.bp.blogspot.com/_FM71j6-VkNE/ScXZ4IOt88I/AAAAAAAABhY/AcRg3ufSAHU/s1600-h/talfbaitandswitch.jpg

    compliments of zero hedge's blog

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  • Comment Link NDbadger Sunday, 22 March 2009 22:08 posted by NDbadger

    Well, if I understand you correctly, the primary difference between the blog results and those of your proprietary account are that when the stock goes against you, you add to your short position. Is this correct?

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  • Comment Link NDbadger Sunday, 22 March 2009 15:22 posted by NDbadger

    If there is a short squeeze on PPD, I hope to be working that day so that I can take advantage of it.

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  • Comment Link 123burke Sunday, 22 March 2009 12:44 posted by 123burke

    Well put Reggie (no pun intended) I have been waiting for the squeeze to enter my position. Hope to get my chance soon!!!

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  • Comment Link Reggie Middleton Sunday, 22 March 2009 10:37 posted by Reggie Middleton

    @TradingBR:
    i was actually being conservative. The spike in volatility could potentially push even the first set of options (in the example) into positive territory. I trade options almost exclusively, particularly over the last two years of this credit crisis. I am quite familiar with their behavior during price spikes and short squeezes. What the market makers due when volatility get's too rough for comfort is to bring their market making activities closer in the horizon curve. If you notice, for the very, very volatile stocks it is quite difficult to get LEAPs or long term expiries, despite the ample liquidity in the underlying. From many of those stocks, 6 months is about as far as you can go.

    Market makers hedge with offsetting options, not the actual underlying, so the short squeeze does not dry up the availability of options. What it may do is allow some "gun to the head, give me all of your money" style bid-ask spreads, though. But think about the VW example. At nearly 1,000, I'll give you your 3 dollar spread. It's a cost of doing business, and it would be very easy for your profits to justify the spread on the way back down to the equilibrium line of 200, which is exactly where VW ag took off from and exactly where it landed.

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  • Comment Link jawadqas Sunday, 22 March 2009 10:01 posted by jawadqas

    Dear Reggie

    PPD's debt payment schedule is as follows:

    Jan to May (5months) ==> US$2.354 per month
    June to December (7 months) ==> US$1.521 per month

    Assuming no new loans.

    They usually renew the 10 Million annual loan for stock re purchases. That would come in June (if they can get it)

    Regards
    Jawad

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  • Comment Link tradingbr Sunday, 22 March 2009 09:30 posted by tradingbr

    You are missing one thing about short squeezes, since there are no shares to short and volatility is on the moon that affects the pricing of the puts, in fact its not unresonable to expect options market markets to pull their quotes completly

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  • Comment Link Reggie Middleton Sunday, 22 March 2009 08:26 posted by Reggie Middleton

    To add to the post above, last week many of the banks went up, some of them 100% plus. Do you really think the hard times are over for the banks? Markets are not efficient over the short term. They are controlled by momentum traders and media quotes. Over the longer term, the broke go bust and the strong survive and flourish. That is the safest and most reliable way to make go about basing your investment strategy, unless of course, you are a momentum trader. That's just not my style, though.

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  • Comment Link Reggie Middleton Sunday, 22 March 2009 08:21 posted by Reggie Middleton

    I've been looking around the net to find the details of the geithner plan and have yet to come up with any besides the WSJ speculation, so I query how so many of you have come to the conclusions that you have reached regarding how good of bad the plan is. Have you actually found the plan or are you speculating as to its construction and contents?

    As for PPD, short squeezes are profit opportunities. I you are a decent money manager, a short squeeze is a guaranteed way of doubling down or tripling down on your profit potential. By definition, a short squeeze is very temporary in nature and not based on the fundamentals so you know for a fact that the position will fall once it finishes spiking. Armed with this knowledge, how could you not make money?

    I see references to short squeezes often in the amateur forums, ex. the Yahoo boards, stating how XYZ will get wiped, etc. If you heed my recommendations of taking bites small enough to afford you the opportunity to go negative or better yet hedge your position with options or take pure options positions, you have manageable or guaranteed caps on losses. This means that you can simply sit back and watch the squeeze occur, and once it is over you should be awashed in profit. Let's take a close look at what was probably the mother of all short squeezes that had so called "professionals" killing themselves and going out of business (due to lack of patience and risk management):

    [img]http://www.marketwatch.com/charts/int-adv.chart?symb=DE:766400&sid=135241&time=8&startdate=&enddate=&freq=1&comp=&compidx=&uf=7168&ma=1&maval=50&type=2&size=1&lf=1&lf2=4&lf3=&style=1013&mocktick=1&rand=143134713[/img]

    Assume you bought ATM puts in VW Ag at 200. It doubles, your puts go OTM, then it startes to fall and you buy more. You have the opportunity to take some profit but you don't break even. You ride it through because you are aware of the Porsche trade. The spike doubled and fell back down in 1 day. Now it spikes again, and you double down again. Then bam! The stock increased 5x fold from 200 to nearly 1000. Instead of panicking, you sit back and wait for the volume and the madness to subside, and you add to your position as it subsides. Your first set of puts would not have broken even, your second set may have eked out a tiny profit or loss, your last go around was Christmas come early, for at least the next 8 years. The only way this would have did you in is if you bit off more than you could chew. That would have been gambling anyway and if you do that you will get wiped sooner or later, regardless - short squeeze or not.

    Short squeezes are always temporal in nature! This is why you always trade off of the fundamentals, and simply be aware of the flow of monies in the market.

    In addition, it is the associates that sell the memberships. If they are found out to be a scam, the memberships simply will not happen. The analogy to Netflix is inappropriate since Netflix relies on conventional sales channels - eg direct over the web, TV and radio advertising wherein PPD relies on the MLM pyramid model of using associates to sell memberships. If associates drop out en masse, no memberships will get sold.

    Just think of what will happen to Netflix if they closed down their marketing web site and no longer advertised...

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  • Comment Link tradingbr Sunday, 22 March 2009 08:03 posted by tradingbr

    duanef,
    you make the point on why I dont think they will get shutdown. The business is dressed as a legitimate business, but their memberships revenue are highly correlated to their associates revenue. With a high churn rate in their sales force they essentially have a bubble business model that will blowup at some point. But I dont think this is madoff, they are a bunch of lawyers, it looks like they are doing some kind of arb in peoples stupidity in a legal way. the deceptive practices have surely gone beyond any legal defense

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  • Comment Link duanef Sunday, 22 March 2009 07:13 posted by duanef

    There seems to be come confusion in these posts about membership v. associates. Yes, few of the Associates make any money. Associate fees are a tiny fraction of the revenue (23M out of 464M). The meat and potatoes is the memberships, which are not designed to be "lucrative." The memberships are simply about giving people legal advice, and there is little here to investigate the quality of the underlying service. Does PPD provide anything of value for the membership fee? It's here the business will make or break. Sure, a bunch of members drop every year. That's what I would expect from small biz owners looking for cheap legal help. But people drop Netflix too, doesn't mean it's a scam. You just have to keep signing 'em up, which so far this co. has been able to do.

    Second comment is that this is a dangerous short. 1.5M shares short (per Yahoo) with 100K daily volume can make for the mother of all short squeeze. You could see this one do a Volkswagen. Be careful out there.

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  • Comment Link thecreature Sunday, 22 March 2009 05:35 posted by thecreature

    "Interestingly, FDR was an aristocrat and he had no problem shutting down insolvent institutions. Obama comes from humble beginnings and has no problem selling out the average American."

    That is one of the best quotes I have read all year

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  • Comment Link NDbadger Sunday, 22 March 2009 05:24 posted by NDbadger

    Yes, it is a huge subsidy for both investors that participate in the government's plan and for the banks. Investors will need to be given a huge subsidy to be motivated to participate and pay something close to the price on the banks' books, and to get to a price that the banks are willing to sell. And the taxpayer bears all the risk. This plan is even worse than the original bad bank proposal.

    So once Reggie asked, is Obama for Wall Street or Main Street? I guess we have our answer.

    Yet it's hard to tell how this will affect markets, because it's not entirely certain the plan will get through. The first two bad bank proposals did not get through (but this one doesn't depend on Congressional funding, as the Fed plans on providing huge, non-recourse loans).

    Although, since this proposal is designed so that few would understand it, it may have a better chance of succeeding. But I think it will come back to bite Obama in the ass. Even the Progressive (a very liberal news outlet) posted an editorial on how the PPIP is an awful idea: http://www.progressive.org/node/127562

    It's also not clear how eager hedge funds will be to participate, even with the government offering such attractive returns. The government is proving itself to be an unreliable partner when push comes to shove (unless of course you are Goldman Sachs or another big bank).

    I have to believe if this gets through, the fallout would shift the House from Democrat to Republican in the next election.

    Interestingly, FDR was an aristocrat and he had no problem shutting down insolvent institutions. Obama comes from humble beginnings and has no problem selling out the average American.

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  • Comment Link thecreature Sunday, 22 March 2009 04:54 posted by thecreature

    Setting moral and fairness considerations aside, isn't the private public investor partnership a huge subsidy for investors? how will this affect markets and the current situation?

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