The Fearful Investor

Was That All?

Ten days ago, on August 16th, the market was in turmoil. The euphamism "Risk was being repriced" didn't do justice to the palpable fear in the markets. The quants were getting creamed, the mortgage market was killing subprime homeowners as well as the investors in their mortgages. Liquidity which once seemed so abundant, dried up so fast that anyone who counted on leverage at recent spreads over treasuries, borrowers and banks alike, were subject to much wider spreads or shutout altogether.

So what happened last week? The stock market bounced back. World economies are still strong, right? The Fed will cut rates, relieving pressure on big banks stuck with mortgages and bridge loans they can't sell, and all will be back to normal.

Sounds good to me, I guess. Except, what happened to the problems that caused the market swoon the prior week? Does a rate cut solve all of that? I know a lot of really smart people with a lot more experience than me that are really scared of the stock market now. I don't have a strong feeling where the market goes from here, but I do find it hard to believe that the level of fear that hit the markets just ten days ago, dissipates so quickly and finally -- even if the Fed cuts rates.

FedEx Hits Truckers While They're Down

Yesterday morning FedEx (FDX) announced a 25% reduction in fuel surcharges on its less-than-truckload (LTL) and freight services. Clearly FedEx sees this as a great opportunity to use their growing international business to grab market share by taking advantage of a weak domestic trucking market to further squeeze their competition, including Arkansas Best (ABFS), Conway (CNW), and Yellow Roadway (YRCW). With many truckers continuing to see year-over-year volume reductions, price reductions kick out another leg of the profitability stool for these companies. On many first quarter earnings calls, the saving grace for LTL truckload providers was a stable price environment despite reduced volumes. Managements trumpeted how consolidation in the LTL industry has made pricing more rational among competitors and profitability should therefore remain stable. To make matters worse for investors in these truckers, they are still trading at premium P/E multiples (while the denominator - earnings - are at risk).

As discussed in my April 27th post, one of the keys in my investment process is to invest in industries with the wind behind their back and truckers have the wind squarely in their face. For industries with the wind in their face, while the primary risk is the expected bad results, the really important secondary risk  is the unexpected even worse developments -- such as increased competition or further fundamental deterioration.

My managed account clients and I are short Arkansas Best Corp.

Understanding Sentiment/Valuation Disconnects

On days like today, when the market is down a bunch, I usually get some client calls that go like this:
Client: Hey Chuck. What's going on with the market?
CG: It seems to be going down.
Client: Well, what do you think?
CG: I dunno. I've picked out a bunch of value-oriented investments which I think ought to do well in most market environments, are reasonably priced, and together form a conservative portfolio. I've got some nifty ideas for new investments, that I'd love to buy if the market keeps coming down like this.
Client: So you're not worried.
CG: I'm always worried. That's my job. To be worried for you, so you don't have to worry.
Client: Ok

While it's been written a million different ways, by all sorts of value investors, I try to tell clients that stock prices go up and down, but behind each ticker is a company that we can ascribe a value to. While this value is subject to change due to macro-factors (such as interest rate fluctuations and economic growth here and abroad) and micro-factors (such as competition and corporate management changes), what happens in the stock market today or tomorrow rarely effects this value.

Market movements are changes in sentiment. Does today's down market or this year's up market mean:
- that domestic trucking tonnages are rising? No.
- that Korean mobile phone churn/ARPU is changing? No.
- that Wal*Mart is suddenly reversing it's plans to reduce growth spending and buyback $15B of stock? No.
- that Chesapeake Energy is having less success drilling for Natural Gas - or, more importantly, that domestic natural gas supply/demand trends are changing? I don't think so.

Stock buying and selling opportunities are created by this disconnect between sentiment and individual company valuation/trends. Knowing how to take advantage of this discrepancy is one key to making money in stock investing.

Why The U.S. Economy Is Like The New York Yankees

I love the Yankees and I think Joe Torre is a swell person, but boy does he know how to wear out a bullpen. Come the 6th inning of a game, Joe's getting ready to run through 3-4 relief pitchers and perhaps warm-up another two. By playoff time, at least three of the relievers are burnt out (not to mention their older starters, too) and the Yanks inevitably lose to a team with fresher arms.

Now, I'm no economist, but the U.S. economy sure feels like a bunch of 'tired arms', too. In 2001, when the internet bubble burst, Greenspan (and his international cohorts) 'went to the bullpen' and lowered short-term interest rates, creating the housing boom. Around the same time, Bush 'warmed up' lower tax rates on capital gains, dividends, and more. As the economy warmed up, while Greenspan lifted rates, worldwide debt levels continued to balloon. Furthermore, a gently falling dollar helps to release some of the pressure of the giant debt load.

With the housing boom now reversing, I wonder who Bernanke/Bush can call in from the proverbial bullpen? As the fed minutes have shown, 'lower rates' can't be brought back yet as inflation will surely follow. The continued yawning U.S. budget deficit probably means that they can't call on lower tax rates, either. And, I don't think we can accelerate the devaluation of the US$ without stoking inflation or seeing other central banks matching with their own devaluations.

Like Joe Torre, our fearless leaders may have no choice later this year but to signal for one of their 'tired arms' to relieve a shaky economy. Here's hoping they have more success than my beloved Yanks have had the last few years!

Security to Checkout! Catalina Marketing is Being Stolen In Plain Sight!

I preface this post with: I know how the world works, and such is life...but here's a story about a management working with private equity firms to steal companies from public shareholders. The company is Catalina Marketing (NYSE Ticker: POS) and the hedge fund playing the role of the private equity firm is Value Act, a well-respected San Fran based hedge fund.  I don't  mean to besmirch any of the players as I believe they are all acting within their rights -- even though it is to the shareholders' detriment. The only party worthy of besmirching then, is the board of Catalina, who may be leaving us shareholders out to dry.

The company being sold, Catalina Marketing is a $1.4B market cap co. with near-100% market-share in point-of-sale marketing at grocery stores/drug stores with coupon printers that produce targeted coupons based on shopper activity as collected in loyalty cards. Catalina is finishing a big upgrade of its printers from black & white to color which has reduced profitability over the last year. The big capital expenditures will finish this summer and company's EBITDA margins (and free cash flows, too!) will rebound -- the same time that this going-private transaction will close...hmmm....

Timeline:
January 2006: ValueAct - 15% shareholder. Partner Jeff Ubben joins Catalina board
Dec. 8, 2006 - POS mgmt confirms rumors that private equity firms have expressed interest in buying co. at $30/share. POS forms special committee. Hires Goldman Sachs as banker.
Feb. 14, 2007 - Reports December Qtr results and reports terminating the sales process.

On the conference call, in response to a question about the bids from outside parties, CEO Dick Buell said the interest from multiple parties "simply did not live up to or match what we think is the right thing for our shareholders and for the company. And that difference of value led us to say we're going to continue on and as we continue on, we think that the stock price in the future will reflect something higher than what the current offers were. I think it's a little harder to come in from the outside and learn about the company and understand the change elements and share the same forecast about the future with the confidence that maybe this management team has..."

When asked about doing a dutch auction to buyback stock, thereby increasing the company's stated position of having a maximum of $200 million of debt on the balance sheet, CFO Rick Frier responded:

"The $200 million question again, Fred, we have a facility today that is a $175 million facility that can go up to $250 million, so there is another view of comfort where we can go. You are looking at EBITDA type multiples, again I appreciate that, but we get to weigh a lot of factors here and we do that and we have looked at this before. We know what the price to do it -- a big share buyback would be that returns well for us versus internal projects. So it fits a lot of different things we look at and we have had this question over the years and it continues to pop up. We used to have $116 million in cash or more and now we are $130 million in debt. So we are progressing there on your leveraged thoughts, but we're at this time again, we are not going to spring into a heavily leveraged (transaction).

Feb. 22, 2007 - ValueAct bids $32/share for POS in a leveraged transaction - just a 7% premium to the lowest bid released publicly. (Herewith heavily leveraged transaction denied by CFO eight days earlier!)

March 8, 2007 - Management accepts ValueAct bid - changing its opinion on both leverage and price.

Only reason I can come up with why management would accept this deal rather than do a dutch auction (i.e. do the leverage on the public co as opposed to taking the company private), is that the financial terms for them/ValueAct is superior to staying public. The chairman of the special committee is hardly a discerning bystander. Frederick Beinecke owns over 5% of the company himself and I'm just guessing  that he's rolling his shares into the private entity.

Such is life in the big city, I guess.