On Wednesday, September 5, 2007, before the opening bell, Sycamore Networks (NASDAQ: SCMR) reported their financial results for the 4th Quarter and Fiscal Year Ended 2007 financial results. The markets were not pleased with the results and it sent SCMR down nearly 8% to close at $3.73. SCMR also missed analyst expectations. The markets were expecting $0.03 EPS for Q4 2007 and $46M in revenue for the same period. SCMR came in at $0.02 EPS and $38M of revenue, respectively. To seemingly make matters worse, SCMR’s Vice President of Finance and Administration stepped down. Sounds like things are falling apart at the Chelmsford, MA based manufacturer of networking hardware and equipment.
Certainly, it could be the case and SCMR could be falling apart and is dead in the water, but I want to point out some observations which suggest to me, that at the very least, SCMR is not going away.
First, since it is a short issue, as for missing analyst expectations, well, really, there is only one analyst – so, what do you expect? While it is no fun to show-off a missed quarter, one estimate – the miss does not carry a great deal of weight.
Regarding the department of the company’s finance chief, the negativity surrounding this event appears to be exaggerated. Certainly, the CFO leaving can easily be interpreted as a red flag, but it certainly does not appear that Mr. Gaynor left on bad terms. Per the conference call, Mr. Gaynor will remain with SCMR for the remainder of the month before pursuing another employment opportunity. He was not fired and it certainly seems that he did not smell a rat, as if he did, he likely would not hang around for the rest of the month. As a shareholder, you never like to see any member of your key management leave, often times, it is just the natural course of things. SCMR should be able to find a competent replacement. The headlines reading “CFO Steps Down” or “Resigns” are technically true, but imply that there is some form of accounting scandal about to come out. This can happen, as anything is possible, but per the nature of his departure, at worst, it is a neutral event.
A big element that has attracted much attention to SCMR over the past few months has been their enormous cash and cash equivalents stash, which grew to $925M from the $904M since the close of Q3 2007. This nearly $1 billion balance translates into about $3.27/share of cash, or about 88% of SCMR’s market value per their September 5, 2007 closing price. SCMR has no debt, either. Although not the ideal way to do it, SCMR continues to produce positive cash (albeit, the huge interest income makes that possible) and this provides a certain baseline to the stock price, which it seems we are close to it at these levels.
A big knock on SCMR has been their inability to produce positive cash flow from operations. Q4 2007 was no exception with a non-GAAP loss from operations of about $5.3M and an operating loss of $19.3M for FYE 2007. Again, the interest on the cash hoard has enabled SCMR to show non-GAAP income from operations. There is little discussion of the revenue growth SCMR has demonstrated the past 12 months. Granted, and SCMR blatantly acknowledges such, that the revenue growth is a result of an acquisition completed in Q1 2007. The growth is not staggering by any means, but showed 133% increase in revenue in Q4 2007 vs. Q4 2007 and 79% revenue growth when you compare the same two periods to each other. This trend, per SCMR’s numbers, appears to be sustainable and the conference call suggests the revenue growth will continue. So, here we have SCMR – showing strong revenue growth and not burning through cash to do so. That is no small accomplishment and does appear to have been ignored by the rest of the world at this stage. Consider an extreme example in XM Satellite Radio which has seen huge revenue growth, but has yet to show an operational profit. However, since they are growing – it is ok to take on debt and post operating losses. SCMR may be being a little too conservative, but imagine being able to have triple digit revenue growth, post very natural (and often widely expected) operational losses for showing revenue growth, and be able to add cash to your bank account – all without taking out loans or debt.
Another noteworthy item, which is not a big secret, is that only a few months ago, SCMR finally cleared up their stock-option backdating situation. SCMR announced that there would be some additional GSA and restructuring charges associated with the completion of the investigation and some subsequent housekeeping. SCMR clearly warned that Q4 2007 would include some additional expenses related to some of these activities. Starting fresh in Q1 2008, the GAAP financial implications of the past should, well, be a thing of the past.
Now, in the words of Yogi Berra, when you come to a fork in the road, you have to take it. That is where SCMR is at now. The healthy balance sheet and revenue growth are very attractive as is SCMR’s exposure to providing equipment to the cable companies and MSOs to service the flexible bandwidth needs of the high speed Internet and digital phone services. However, as everyone knows, SCMR has been unable to show any form of operating profit the past several years. The pieces are in place for SCMR to turn the corner and should they show an operating profit, which I believe they will in Q2 or Q3 2008 (or perhaps Q1 2008), the company’s stock price should respond very positively and very quickly.
Now obviously, SCMR needs to perform and unfortunately, some of the executive’s answers during the conference call were somewhat vague and perhaps indicate a disinterest or mild incompetence to really make this thing go.
However, even if the above is the case, SCMR is now trading where it was when it was showing less revenue growth, had less cash in the bank, and was mired in non-compliance and options back-dating issues. It would suggest that the pieces (cash, revenue growth, industry with demand) are in place for SCMR to be a potential 2x-5x bagger over the next 12-24 months. Now, granted, that may not happen and it absolutely is a gamble – but what’s the downside? Considering you are basically buying the stock at a slight premium to book value (with over 90% of that book value being in greenbacks), this looks like a win or no-lose scenario. I used today’s dip to increase my holdings by 17%.
Wednesday, September 5, 2007
Tuesday, September 4, 2007
RealNetworks (NASDAQ: RNWK) – It Looks Good, But It’s Not Great- Buy at $6.23
First, let me say that I like RealNetworks, Inc. (NASDAQ: RNWK). I think it is a safe investment – and I think at its recent closing price of $6.23, it has some upside. I feel $9-$11 is a realistic price target for this one, though it may not happen. I must admit, that I am a buyer of RNWK at these levels and have been slowly nibbling away at this one. It just looks to be a very safe play with some things coming together that can result in upside.
As for the merits of RNWK, those are no secret.
The biggest factor, I believe, that will hinder RNWK from becoming a 10-bagger is the CEO and Founder, Rob Glaser. I am not suggesting Glaser is incompetent by any means – in fact, I think he has done, at the very least, a satisfactory job of diversifying the company and expanding from a technology service to an entertainment/media company. Recall that RNWK’s primary business used to be technology licensing of their streaming media technology. RNWK still has that line of business but also has a slew of other offerings and new deals in place that can drive their more exciting business lines: music, gaming, entertainment, mobile.
Glaser, by virtue of being the founder, owns about 30% of RNWK and in 2006, from June to December, parted with over $12M of stock at around $10.50-$11.00 per share. Certainly, that is his prerogative and I do not blame him for it, but that $12M was about 12% of the $100M RNWK stock buyback program. The matter of a buyback program is nothing new. RNWK completed their 2005 and 2006 buyback programs and it appears that they will with their most recently announced repurchase program. If Glaser is not enough, note that between March 31, 2007 and June 30, 2007, institutions registered net selling of 28,427,000 shares – that dollar volume far exceeding the RNWK buyback efforts. Simple supply and demand – if there are more sellers than buyers, price goes down. To get to the point, the RNWK buyback is a good gesture but is not accomplishing the real purpose of what a buyback should accomplish. Simplistically, it is simply allowing some of the larger institutions and Glaser to part with some of his shares (albeit a small % of his shares). If there were no sellers, than the buyback would be a very bullish indicator for the stock and seem to be a prelude to higher levels.
From an acquisition standpoint, the size of Glaser’s holdings and his well publicized liquidation of shares at the $10.50-$11.00 level, even if premeditated by a company approved 10b5-1 plan, shows that he is willing to let some go at that price. If he is willing to let go of some at that price, basic logic suggests that he would be willing to take less to get rid of them all in one shot. I believe that many possible buyers of RNWK exist. Google, for sure is one of them, but it seems they are working with gBox for their digital music future. However, the RNWK gaming platform might make sense as Google has yet to offer a Google Games, a piece of the puzzle they currently do not have and their top competitors (Microsoft, AOL, Yahoo!) do. Any of the ILECs, such as Verizon or AT&T are possible suitors. The cable companies, perhaps Comcast or Time Warner, may make a good fit. Universal Group may also be a candidate to take out RNWK. Wal-Mart, Yahoo!, or Microsoft? Well, maybe, but all three already have their own digital music solutions available to their traffic base.
Unfortunately for RNWK and those looking for pie in the sky, the takeover price would likely be in the $8-$9 range – which, mind you, is still a strong premium over Friday’s closing price. However, my best guess suggests that such an offer would not be acceptable to the RNWK board and shareholders (e.g., Glaser) at this stage. I believe the opportunity is there, but really is more of a Plan B if the newly announced initiatives do not work out – consider it like a bail-out or a cushion. This will leave RNWK to fend for its own and try to drive shareholder value through its own internal efforts, which may or may not work out.
Why is the buyout price seemingly so low? Funny – who thinks a 30% premium is low? It does not seem that way, but a 30% from the company’s recent price is also 30% less than the company’s 52-week high and fractionally lower than the triple-digit price RNWK traded at during the peak of the Internet bubble.
Well, the Glaser selling spree is part of the equation as is RNWK is participating in an increasingly commodity-driven business. This element is the second aspect as to why RNWK is trading at these apparent low prices. The online music business simply is not exciting and as everyone in the world seems to get into it and the major labels become more receptive to it, it eliminates some of the premium given to the industry. Players like eMusic, which used to be public, gave way to a private equity-buyer. Napster, which is a popular name in the space, has yet to turn a profit. iTunes is the dominant leader, but only because they have the captive audience of the iPhone and iPod to basically force people to use their digital music platform. Furthermore, Apple is in the hardware business – not the digital subscription business. Even with the royalty-free usage being endorsed by some of the record labels, you are seeing Wal-Mart get into the game and will obviously do whatever it takes to be the lowest cost provider of digital music downloads around. The end-result, once Wal-Mart is in the game, the sexiness is out – hence no major market premium.
To summarize, RNWK is a solid company and it appear s there is some upside in this one based on the condition of the balance sheet and an array of new opportunities on the horizon. However, the digital music business is just not that exciting any more, now that it seems anyone can get into it. Plus, Glaser has already played his hand of the price he is willing to let go of this one. RNWK may be worth more than $6, and I agree with that sentiment, but given the status quo, it’s certainly not worth more than $10 to any potential suitor.
So, is RNWK a winner? Well, yes, I believe it is and has some upside and limited downside. Perhaps shareholders may get a boost from the plethora of new developments and agreements RNWK is moving into, especially in the gaming, music, and mobile spaces.
Just your classic case of if it’s too good to be true, it probably is. RNWK is worth $9-$11 per share – but no more – and if their new relationships do not pan out, it could be at $6-$7 for a long-time. I still like RNWK, especially at under $6.00. Be smart with this one – and be realistic – and all should fall nicely into place – particularly if your mindset is to stack nickels in your portfolio over the long-haul rather than try to shoot the moon. If you belong to the latter group of investors, well, then RNWK is not going to make you happy. The only person getting rich off RNWK will be Glaser, but the upside leaves a little bit of crumbs for the rest of us bottom-feeders. For me, for 30%-50% upside, well, I’ll bottom-feed all day.
My point is happy buying, but do not expect a double or a triple and I would advise not waiting for it. We all say we are ok with 30%-50% gains in a 12-24 month period, but considering AAPL’s double in the past year, it may be easy for your eyes to get bigger than your stomach with this one. Let’s keep it Real.
As for the merits of RNWK, those are no secret.
- Slew up upgrades, including the most recent buy rating by Pacific Growth Equities on August 31, 2007 and a $11 price target from Think Equity on August 27, 2007;
- A parade of new deals and announcements with Verizon/MTV in an effort to rival iTunes;
- Lots of cash ($4/share), nominal debt, and trading right around 1x book value.
- Significant stock buyback program in place.
The biggest factor, I believe, that will hinder RNWK from becoming a 10-bagger is the CEO and Founder, Rob Glaser. I am not suggesting Glaser is incompetent by any means – in fact, I think he has done, at the very least, a satisfactory job of diversifying the company and expanding from a technology service to an entertainment/media company. Recall that RNWK’s primary business used to be technology licensing of their streaming media technology. RNWK still has that line of business but also has a slew of other offerings and new deals in place that can drive their more exciting business lines: music, gaming, entertainment, mobile.
Glaser, by virtue of being the founder, owns about 30% of RNWK and in 2006, from June to December, parted with over $12M of stock at around $10.50-$11.00 per share. Certainly, that is his prerogative and I do not blame him for it, but that $12M was about 12% of the $100M RNWK stock buyback program. The matter of a buyback program is nothing new. RNWK completed their 2005 and 2006 buyback programs and it appears that they will with their most recently announced repurchase program. If Glaser is not enough, note that between March 31, 2007 and June 30, 2007, institutions registered net selling of 28,427,000 shares – that dollar volume far exceeding the RNWK buyback efforts. Simple supply and demand – if there are more sellers than buyers, price goes down. To get to the point, the RNWK buyback is a good gesture but is not accomplishing the real purpose of what a buyback should accomplish. Simplistically, it is simply allowing some of the larger institutions and Glaser to part with some of his shares (albeit a small % of his shares). If there were no sellers, than the buyback would be a very bullish indicator for the stock and seem to be a prelude to higher levels.
From an acquisition standpoint, the size of Glaser’s holdings and his well publicized liquidation of shares at the $10.50-$11.00 level, even if premeditated by a company approved 10b5-1 plan, shows that he is willing to let some go at that price. If he is willing to let go of some at that price, basic logic suggests that he would be willing to take less to get rid of them all in one shot. I believe that many possible buyers of RNWK exist. Google, for sure is one of them, but it seems they are working with gBox for their digital music future. However, the RNWK gaming platform might make sense as Google has yet to offer a Google Games, a piece of the puzzle they currently do not have and their top competitors (Microsoft, AOL, Yahoo!) do. Any of the ILECs, such as Verizon or AT&T are possible suitors. The cable companies, perhaps Comcast or Time Warner, may make a good fit. Universal Group may also be a candidate to take out RNWK. Wal-Mart, Yahoo!, or Microsoft? Well, maybe, but all three already have their own digital music solutions available to their traffic base.
Unfortunately for RNWK and those looking for pie in the sky, the takeover price would likely be in the $8-$9 range – which, mind you, is still a strong premium over Friday’s closing price. However, my best guess suggests that such an offer would not be acceptable to the RNWK board and shareholders (e.g., Glaser) at this stage. I believe the opportunity is there, but really is more of a Plan B if the newly announced initiatives do not work out – consider it like a bail-out or a cushion. This will leave RNWK to fend for its own and try to drive shareholder value through its own internal efforts, which may or may not work out.
Why is the buyout price seemingly so low? Funny – who thinks a 30% premium is low? It does not seem that way, but a 30% from the company’s recent price is also 30% less than the company’s 52-week high and fractionally lower than the triple-digit price RNWK traded at during the peak of the Internet bubble.
Well, the Glaser selling spree is part of the equation as is RNWK is participating in an increasingly commodity-driven business. This element is the second aspect as to why RNWK is trading at these apparent low prices. The online music business simply is not exciting and as everyone in the world seems to get into it and the major labels become more receptive to it, it eliminates some of the premium given to the industry. Players like eMusic, which used to be public, gave way to a private equity-buyer. Napster, which is a popular name in the space, has yet to turn a profit. iTunes is the dominant leader, but only because they have the captive audience of the iPhone and iPod to basically force people to use their digital music platform. Furthermore, Apple is in the hardware business – not the digital subscription business. Even with the royalty-free usage being endorsed by some of the record labels, you are seeing Wal-Mart get into the game and will obviously do whatever it takes to be the lowest cost provider of digital music downloads around. The end-result, once Wal-Mart is in the game, the sexiness is out – hence no major market premium.
To summarize, RNWK is a solid company and it appear s there is some upside in this one based on the condition of the balance sheet and an array of new opportunities on the horizon. However, the digital music business is just not that exciting any more, now that it seems anyone can get into it. Plus, Glaser has already played his hand of the price he is willing to let go of this one. RNWK may be worth more than $6, and I agree with that sentiment, but given the status quo, it’s certainly not worth more than $10 to any potential suitor.
So, is RNWK a winner? Well, yes, I believe it is and has some upside and limited downside. Perhaps shareholders may get a boost from the plethora of new developments and agreements RNWK is moving into, especially in the gaming, music, and mobile spaces.
Just your classic case of if it’s too good to be true, it probably is. RNWK is worth $9-$11 per share – but no more – and if their new relationships do not pan out, it could be at $6-$7 for a long-time. I still like RNWK, especially at under $6.00. Be smart with this one – and be realistic – and all should fall nicely into place – particularly if your mindset is to stack nickels in your portfolio over the long-haul rather than try to shoot the moon. If you belong to the latter group of investors, well, then RNWK is not going to make you happy. The only person getting rich off RNWK will be Glaser, but the upside leaves a little bit of crumbs for the rest of us bottom-feeders. For me, for 30%-50% upside, well, I’ll bottom-feed all day.
My point is happy buying, but do not expect a double or a triple and I would advise not waiting for it. We all say we are ok with 30%-50% gains in a 12-24 month period, but considering AAPL’s double in the past year, it may be easy for your eyes to get bigger than your stomach with this one. Let’s keep it Real.
Wednesday, August 22, 2007
Interest Rate Cut – Sleep it Off!
What?!?! You loaned money to people that could not afford it and now you want someone to bail you out? Big shocker. ME, ME, ME is all I hear – similar to a 4-year old in a candy store when it comes to the well-publicized events of the sub prime mortgage ‘meltdown’ and the debate of whether the Fed should cut interest rates.
I will be the first to say that I am not a heavily trained economist and I have no advanced degrees in the subject. Furthermore, I must admit that I do not have access to a fraction of the information that these people do – and in the event that I did, I would be hard pressed to make any sense of it.
However, that does not stop me from running my mouth on the issue – everyone else seems to be doing so, so why not join the party?
First, there is no doubt that things have been tough out there. We have seen a couple of Wall Street’s more adored lenders, banks, and mortgage REITs take monster hits on people. From declining stock price, to wiping out lots of net worth, to companies going under and leaving thousands of people with out jobs – it is rough. The situation is further exacerbated by the real estate market slow down – leaving many related professionals (realtors, mortgage brokers, developers, home builders, etc.) without income or a much smaller source of such. Living in South Florida, which was arguably the hottest real estate market in the country during the boom has provided me some very basic, observational insight on the situation.
It seemed that everyone here in the area became a realtor – everyone was looking to flip homes – everyone was writing big-ticket mortgages. For a while, things were good, but then the inevitable happened – things slowed down. Why did things slow down? Simplistically, let’s be honest – people ran out of money, especially in the area I come from. If people had more money, people would still be buying the flipped homes, realtors would be earning commissions, builders would still be building to sell to the masses, and mortgage lenders would still be madly filling out applications. But, it stopped? Again, people ran out of money. I do not want to hear that all of a sudden the mass population of Americans suddenly started subscribing to value investing and changed their financial tone. There was literally no more money left.
I would always wonder when the lack of top-quality paying jobs in the area would finally catch up with the real estate marketplace here. I could not compute the math on how people were affording high-priced homes on mediocre salaries. I was always wondering at what point does this behavior trickle into the overall local economy? Well, it has – and it is showing up here in the area. Restaurants are slower and waitresses I speak with are telling me this past winter season was the slowest in a while, the summer was slower than usual, and this upcoming year is also supposed to be slow. Membership applications to golf clubs have slowed – and in some cases, many want out but cannot sell because there are no buyers. Small businesses – especially one-man shows that do business with other one-man shows – are complaining about clients taking longer to pay them – rather than getting paid within 15-20 days, checks are showing up 40-50 days after the invoice and a phone call. It all adds up.
Next, do not kid yourself that this issue is restricted to a small, non-metropolitan area in South Florida. The signs are all there and are showing up nationwide. Some examples:
All of the major cable companies are reporting slowdown in subscriber growth for their high speed Internet and digital cable TV services. Charter, for instance, had great additions of their digital phone product, but flat growth in their cable TV subscribers. DISH Network flat out blamed the slower home market for slower sales;
Home Depot, Nordstrom, and even Wal-Mart said they are seeing weaker consumer spending. The first two also cited that payments on their company-financed credit cards to customers are coming in slower and we are seeing more late payments.
Foreclosures are up – everyone knows this.
Apple iPhone sales appear to have slowed since they first exploded onto the spot. I do not have the numbers to back this up, but think about yourself or your friends that got one. They all got them the first week they hit the market – not a lot of new iPhone buyers since then. Personally, I am not sure where people are coming up with the $600 for this device. Actually, I take that back – I know one person that actually padded his mileage on his expense report to be able to foot the bill. Harmless to a big company, right, but it comes out of someone’s pocket.
The biggest news item I have seen that overall, the average American savings rate is in the negative numbers. That is, on average, people are spending more than they are making. Eventually, the well runs dry.
Previously, Greenspan saw what was going on and warned that a recession by the end of 2007 or early 2008 was a distinct possibility. I hate to also sound like a psychic, but many of my past writing from early 2007 cited many of the above reasons and that at some point, it would have to filter into the overall economy and hit the marketplace. Of course, I had no idea on the timing of such, the absolute freezing of the mortgage paper marketplace, and the extent that albeit it for a short time, the stock market actually endured a correction (10%+) on an intra-day basis.
So, what is the source of the above issues? Since nobody is flat out saying it, I will say it. Why is everyone so surprised about this? For years, banks and credit cards have been loaning money to people that frankly could not afford it. I am not merely singling out those that are classified as sub prime. People with 750+ credit scores were being loaned boat loads of money, often unsecured, to do whatever with. Buy a bigger house, invest in a half-baked business idea, buy new cars, go out to eat all the time. Nobody is saving this money and investing it – if they were, the savings rate would not be negative, right? So, now that banks have loaned money to people that could not afford to pay it back, they want someone to bail them out.
Reward bad business decision making? That is what it sounds like, but it may be too aggressive. Consider this perspective. I have read, cover-to-cover, a big book called Responsibilities of Corporate Officers & Directors Under Federal Securities Law. It was the most boring thing ever, but the biggest thing I took with me was the discussion on what you can get busted on, for lack of a better phrase, when it comes to the collapse of a business. Obviously, anyone can sue anyone for anything these days, but realistically, what qualifies as an event that can genuinely be prosecuted? Specifically and simplistically, if you have a business plan and it appears you put thought into it with the intent to turn a profit and reward shareholders, you are in the clear. Translation, you cannot be punished for a bad business idea. Not all businesses work – that is a reality. If your intent is to defraud or steal, well, then you have problems. But, you cannot go down in flames if the business idea, with some analysis showing it might work, simply did not pan out. Even a chance of a business panning out is enough, considering that most small businesses fail. I have heard a slew of statistics from 75% in the first year to 90% within 5-years – who knows – but the reality is, most business ideas do not make it to profitability.
As for how this impacts the banks and lenders. Well, again, very simplistically their take was to loan as much money as possible to pretty much whoever. For a while, this was making the banks a lot of money – there is no question. The business plan showed that it could work in theory and for a while it did. So, all is well. Honestly, the system could have continued to work and drive things the way it did, but people stopped paying their bills. That is where we are today. Businesses, lenders, banks, and many more engaged in the practice of turning a profit and the business idea simply just did not work out.
So, with the writing on the wall, why is everyone now calling for an interest rate cut and whining to do so? I think it comes down to wanting someone to bail them out. The now famous Jim Cramer meltdown video basically saw him whining and crying about ‘how tough it is out there’ and that the Fed should come to the rescue. Remember – the Fed is not the enemy here – the practices of America as a whole is what caused this blip.
Overall, at least to me, things look good. Sure, growth has slowed in some cases, but revenues are up, profitability is up (even if at slower rates), people are employed. Business has not ceased to exist and continues to function very well. Some in the credit markets might claim exception to this, but how is this different from technology consulting companies facing the Internet Bubble collapse or travel companies facing the events of 9/11? It’s not – it is just part of doing business and there is absolutely no reason to be bailed out.
How many of you still reading this article (sorry for the length) have run into tough financial times? How many of you have had businesses you owned fall apart or have slow year? Who was there to bail you out? Nobody. Sure, clients help and the government has programs to facilitate the development of business, but nobody was just going to write you a check to cover your losses. And in the event they did, what are the odds of you tightening the belt and just walking away? Slim to none – as more often than not, people that are bailed out of their credit card debt by a family member or bankruptcy often return to the same fate. Forget statistics – I would venture to say we all have a handful of friends that are in over their head, were able to get out of it, and then fall right back into the precipice of debt.
The stock markets are pushing for a rate cut – and it very well may happen. The stock markets, though, want it now it seems and do not feel like waiting until the September 18 meeting. Many economists are now saying one will happen, and it very well may. Should such a cut happen, it will be interesting to see how that actually affects the stock markets. It makes one wonder if some of the upside is already getting priced in by the markets expecting such activity. Note today’s (August 22) climb in the major indices.
So, what happens if the Fed does not cut rates and leaves them the same, as they have been saying for a while. The panic returns and the markets continue a downward decline. Honestly, that does not seem like a horrible idea. Nobody likes their stocks going down, but it has been up-up-and-away since Fall, 2006. It may be time for a breather. Additionally, we have seen the U.S. Dollar strengthen against the British Pound and the Euro in the past few weeks suggesting that this may be a good path to go down. Overall, this is good news for the Dollar and for our economy as a whole. Sure, $1 is $1 here, but the more liquidity added, the more it is going to hurt our country’s economy in the long run.
Also, all things are possible. Explain how the interest rates in Europe are lower than ours here in the USA and yet, their respective currencies have strengthened, and their countries have avoided much of the debacle of the mortgage fall out. Honestly, I think the Fed would be amenable to lowering the rate if they were convinced that banks and Americans would change their ways somewhat and practice fiscal responsibility. However, as mentioned above, adding more liquidity would likely just contribute to the same poor spending practices by consumers and loose lending guidelines by banks.
I really believe that we need to let this situation filter out naturally. It is not some Force Majeure event – there is a very direct, logical explanation for such. Additionally, consider that the markets have yet to endure an actual correction on a closing price basis. The markets are down about 7% since their highs (less than the 10% required to officially call it a correction) and are still up about 6% YTD, despite the steep recent decline. Further consider that September and August, historically, are the stock markets two weakest months of the entire year – and the closing months of the year tends to be strong.
I am not suggesting maliciously punishing anyone, but we cannot just let the effected companies off of the hook at the expense of our entire economy – only to create a situation that will most likely spawn an even more severe situation in the future. This is a storm that must be weathered – and frankly, it is not that bad of a storm. The interest rate cut needs to be restrained until it is really needed – when inflation does start to spiral out of control or business becomes universally stagnant. Like antibiotics, you do not want to take them to much because each time you do, it makes them that much less effective when you might actually really need them.
Also, do not take me for a bear – I want things to go up, up, and away all the time myself. In fact, I have a couple of positions that I would like to see go through the roof as soon as possible. Why? Well, and I embarrassingly say this, but to ‘bail me out’ of some issues. As much as I would like that happen, I am well capable of bailing myself out and having someone bail me out now frankly would not help me for the long-haul.
So, this horrible malady that we are effected with is really not all that bad and there are intelligible, logical steps that can be done without waving the magic interest rate wand. Sleep it off.
I will be the first to say that I am not a heavily trained economist and I have no advanced degrees in the subject. Furthermore, I must admit that I do not have access to a fraction of the information that these people do – and in the event that I did, I would be hard pressed to make any sense of it.
However, that does not stop me from running my mouth on the issue – everyone else seems to be doing so, so why not join the party?
First, there is no doubt that things have been tough out there. We have seen a couple of Wall Street’s more adored lenders, banks, and mortgage REITs take monster hits on people. From declining stock price, to wiping out lots of net worth, to companies going under and leaving thousands of people with out jobs – it is rough. The situation is further exacerbated by the real estate market slow down – leaving many related professionals (realtors, mortgage brokers, developers, home builders, etc.) without income or a much smaller source of such. Living in South Florida, which was arguably the hottest real estate market in the country during the boom has provided me some very basic, observational insight on the situation.
It seemed that everyone here in the area became a realtor – everyone was looking to flip homes – everyone was writing big-ticket mortgages. For a while, things were good, but then the inevitable happened – things slowed down. Why did things slow down? Simplistically, let’s be honest – people ran out of money, especially in the area I come from. If people had more money, people would still be buying the flipped homes, realtors would be earning commissions, builders would still be building to sell to the masses, and mortgage lenders would still be madly filling out applications. But, it stopped? Again, people ran out of money. I do not want to hear that all of a sudden the mass population of Americans suddenly started subscribing to value investing and changed their financial tone. There was literally no more money left.
I would always wonder when the lack of top-quality paying jobs in the area would finally catch up with the real estate marketplace here. I could not compute the math on how people were affording high-priced homes on mediocre salaries. I was always wondering at what point does this behavior trickle into the overall local economy? Well, it has – and it is showing up here in the area. Restaurants are slower and waitresses I speak with are telling me this past winter season was the slowest in a while, the summer was slower than usual, and this upcoming year is also supposed to be slow. Membership applications to golf clubs have slowed – and in some cases, many want out but cannot sell because there are no buyers. Small businesses – especially one-man shows that do business with other one-man shows – are complaining about clients taking longer to pay them – rather than getting paid within 15-20 days, checks are showing up 40-50 days after the invoice and a phone call. It all adds up.
Next, do not kid yourself that this issue is restricted to a small, non-metropolitan area in South Florida. The signs are all there and are showing up nationwide. Some examples:
All of the major cable companies are reporting slowdown in subscriber growth for their high speed Internet and digital cable TV services. Charter, for instance, had great additions of their digital phone product, but flat growth in their cable TV subscribers. DISH Network flat out blamed the slower home market for slower sales;
Home Depot, Nordstrom, and even Wal-Mart said they are seeing weaker consumer spending. The first two also cited that payments on their company-financed credit cards to customers are coming in slower and we are seeing more late payments.
Foreclosures are up – everyone knows this.
Apple iPhone sales appear to have slowed since they first exploded onto the spot. I do not have the numbers to back this up, but think about yourself or your friends that got one. They all got them the first week they hit the market – not a lot of new iPhone buyers since then. Personally, I am not sure where people are coming up with the $600 for this device. Actually, I take that back – I know one person that actually padded his mileage on his expense report to be able to foot the bill. Harmless to a big company, right, but it comes out of someone’s pocket.
The biggest news item I have seen that overall, the average American savings rate is in the negative numbers. That is, on average, people are spending more than they are making. Eventually, the well runs dry.
Previously, Greenspan saw what was going on and warned that a recession by the end of 2007 or early 2008 was a distinct possibility. I hate to also sound like a psychic, but many of my past writing from early 2007 cited many of the above reasons and that at some point, it would have to filter into the overall economy and hit the marketplace. Of course, I had no idea on the timing of such, the absolute freezing of the mortgage paper marketplace, and the extent that albeit it for a short time, the stock market actually endured a correction (10%+) on an intra-day basis.
So, what is the source of the above issues? Since nobody is flat out saying it, I will say it. Why is everyone so surprised about this? For years, banks and credit cards have been loaning money to people that frankly could not afford it. I am not merely singling out those that are classified as sub prime. People with 750+ credit scores were being loaned boat loads of money, often unsecured, to do whatever with. Buy a bigger house, invest in a half-baked business idea, buy new cars, go out to eat all the time. Nobody is saving this money and investing it – if they were, the savings rate would not be negative, right? So, now that banks have loaned money to people that could not afford to pay it back, they want someone to bail them out.
Reward bad business decision making? That is what it sounds like, but it may be too aggressive. Consider this perspective. I have read, cover-to-cover, a big book called Responsibilities of Corporate Officers & Directors Under Federal Securities Law. It was the most boring thing ever, but the biggest thing I took with me was the discussion on what you can get busted on, for lack of a better phrase, when it comes to the collapse of a business. Obviously, anyone can sue anyone for anything these days, but realistically, what qualifies as an event that can genuinely be prosecuted? Specifically and simplistically, if you have a business plan and it appears you put thought into it with the intent to turn a profit and reward shareholders, you are in the clear. Translation, you cannot be punished for a bad business idea. Not all businesses work – that is a reality. If your intent is to defraud or steal, well, then you have problems. But, you cannot go down in flames if the business idea, with some analysis showing it might work, simply did not pan out. Even a chance of a business panning out is enough, considering that most small businesses fail. I have heard a slew of statistics from 75% in the first year to 90% within 5-years – who knows – but the reality is, most business ideas do not make it to profitability.
As for how this impacts the banks and lenders. Well, again, very simplistically their take was to loan as much money as possible to pretty much whoever. For a while, this was making the banks a lot of money – there is no question. The business plan showed that it could work in theory and for a while it did. So, all is well. Honestly, the system could have continued to work and drive things the way it did, but people stopped paying their bills. That is where we are today. Businesses, lenders, banks, and many more engaged in the practice of turning a profit and the business idea simply just did not work out.
So, with the writing on the wall, why is everyone now calling for an interest rate cut and whining to do so? I think it comes down to wanting someone to bail them out. The now famous Jim Cramer meltdown video basically saw him whining and crying about ‘how tough it is out there’ and that the Fed should come to the rescue. Remember – the Fed is not the enemy here – the practices of America as a whole is what caused this blip.
Overall, at least to me, things look good. Sure, growth has slowed in some cases, but revenues are up, profitability is up (even if at slower rates), people are employed. Business has not ceased to exist and continues to function very well. Some in the credit markets might claim exception to this, but how is this different from technology consulting companies facing the Internet Bubble collapse or travel companies facing the events of 9/11? It’s not – it is just part of doing business and there is absolutely no reason to be bailed out.
How many of you still reading this article (sorry for the length) have run into tough financial times? How many of you have had businesses you owned fall apart or have slow year? Who was there to bail you out? Nobody. Sure, clients help and the government has programs to facilitate the development of business, but nobody was just going to write you a check to cover your losses. And in the event they did, what are the odds of you tightening the belt and just walking away? Slim to none – as more often than not, people that are bailed out of their credit card debt by a family member or bankruptcy often return to the same fate. Forget statistics – I would venture to say we all have a handful of friends that are in over their head, were able to get out of it, and then fall right back into the precipice of debt.
The stock markets are pushing for a rate cut – and it very well may happen. The stock markets, though, want it now it seems and do not feel like waiting until the September 18 meeting. Many economists are now saying one will happen, and it very well may. Should such a cut happen, it will be interesting to see how that actually affects the stock markets. It makes one wonder if some of the upside is already getting priced in by the markets expecting such activity. Note today’s (August 22) climb in the major indices.
So, what happens if the Fed does not cut rates and leaves them the same, as they have been saying for a while. The panic returns and the markets continue a downward decline. Honestly, that does not seem like a horrible idea. Nobody likes their stocks going down, but it has been up-up-and-away since Fall, 2006. It may be time for a breather. Additionally, we have seen the U.S. Dollar strengthen against the British Pound and the Euro in the past few weeks suggesting that this may be a good path to go down. Overall, this is good news for the Dollar and for our economy as a whole. Sure, $1 is $1 here, but the more liquidity added, the more it is going to hurt our country’s economy in the long run.
Also, all things are possible. Explain how the interest rates in Europe are lower than ours here in the USA and yet, their respective currencies have strengthened, and their countries have avoided much of the debacle of the mortgage fall out. Honestly, I think the Fed would be amenable to lowering the rate if they were convinced that banks and Americans would change their ways somewhat and practice fiscal responsibility. However, as mentioned above, adding more liquidity would likely just contribute to the same poor spending practices by consumers and loose lending guidelines by banks.
I really believe that we need to let this situation filter out naturally. It is not some Force Majeure event – there is a very direct, logical explanation for such. Additionally, consider that the markets have yet to endure an actual correction on a closing price basis. The markets are down about 7% since their highs (less than the 10% required to officially call it a correction) and are still up about 6% YTD, despite the steep recent decline. Further consider that September and August, historically, are the stock markets two weakest months of the entire year – and the closing months of the year tends to be strong.
I am not suggesting maliciously punishing anyone, but we cannot just let the effected companies off of the hook at the expense of our entire economy – only to create a situation that will most likely spawn an even more severe situation in the future. This is a storm that must be weathered – and frankly, it is not that bad of a storm. The interest rate cut needs to be restrained until it is really needed – when inflation does start to spiral out of control or business becomes universally stagnant. Like antibiotics, you do not want to take them to much because each time you do, it makes them that much less effective when you might actually really need them.
Also, do not take me for a bear – I want things to go up, up, and away all the time myself. In fact, I have a couple of positions that I would like to see go through the roof as soon as possible. Why? Well, and I embarrassingly say this, but to ‘bail me out’ of some issues. As much as I would like that happen, I am well capable of bailing myself out and having someone bail me out now frankly would not help me for the long-haul.
So, this horrible malady that we are effected with is really not all that bad and there are intelligible, logical steps that can be done without waving the magic interest rate wand. Sleep it off.
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