Young Money - Why Value Investing In Tech And Retail Companies Doesn't Work

New post:

"To accurately value a business, investors need a guide as to what margins and economic returns it will earn. Past results are often the best guide: if an industry has earned a 10% average return on equity over multiple economic cycles, but it's currently losing money because of a recession or overcapacity, then it's likely to earn a 10% ROE again at some point. Some companies in the industry may go bankrupt, but when supply and demand adjust, the survivors will profit. In other words, the typical industry reverts to the mean.

By contrast, new technology standards and products replace old ones all the time. Instead of reverting to the mean, struggling tech companies usually revert to non-existence. The same is true for retail: what people like to buy and where they like to buy it change constantly."

Recently, many value investors have had to figure this out the hard way.

I don't understand the "Standard General" (ridiculous name) hedge fund guy who keeps sniffing around American Apparel and Radio Shack.

"1939 to 2005 RADIO SHACK GENERAL CATALOG ARCHIVE" $RSH

This is amazing - somebody has compiled all of the Radio Shack catalogs ever published. Also, I didn't realize that they are apparently no longer publishing a catalog:

"Radio Shack currently publishes an in-store catalog called the Assortment Book or Assortment Guide. These are not available to the public and are usually limited to one copy per store."

I don't actually agree with the notion that Radio Shack needs to return to its roots. Selling electronic parts out of storefronts has been killed by many things: miniaturization, smartphones (a product of miniaturization), and Amazon. That's why my proposal was that the business should be in runoff. No capex, no pivots.

The Kelly Capital Growth Investment Criterion: Theory and Practice

This is from Taleb's review of The Kelly Capital Growth Investment Criterion: Theory and Practice:

"There are two methods to consider in a risky strategy.

1) The first is to know all parameters about the future and engage in optimized portfolio construction, a lunacy unless one has a god-like knowledge of the future. Let us call it Markowitz-style. In order to implement a full Markowitz- style optimization, one needs to know the entire joint probability distribution of all assets for the entire future, plus the exact utility function for wealth at all future times. And without errors! (I have shown that estimation errors make the system explode.)

2) Kelly's method (or, rather, Kelly-Thorpe), developed around the same period, which requires no joint distribution or utility function. It is very robust. In practice one needs to estimate the ratio of expected profit to worst- case return-- dynamically adjusted to avoid ruin. In the case of barbell transformations, the worst case is guaranteed (leave 80% or so of your money in reserves). And model error is much, much milder under Kelly criterion. So, assuming one has the edge (as a sole central piece of information), engage in a dynamic strategy of variable betting, getting more conservative after losses ('cut your losses') and more aggressive 'with the house's money'. The entire focus is the avoidance of gambler's ruin.

The first strategy was only embraced by academic financial economists --empty suits without skin in the game -- because you can make an academic career writing BS papers with method 1 much better than with method 2. On the other hand EVERY SURVIVING speculator uses explicitly or implicitly method 2 (evidence: Ray Dalio, Paul Tudor Jones, Renaissance, even Goldman Sachs!) For the first method, think of LTCM and the banking failure.

Let me repeat. Method 2 is much, much, much more scientific in the true sense of the word, that is rigorous and applicable. Method 1 is good for 'job market papers'"

I have a copy which I haven't read yet. It's an academic volume; the layman and investor's book on Kelly is the excellent Fortune's Formula.

"Big Medicine and Big Energy"

A correspondent wrote in response to our review of Happy Accidents: Serendipity in Modern Medical Breakthroughs by Morton A. Meyers,

"Big medicine and big energy share a morbid feature. Big medicine cannot deliver cheap, safe, un-patented medicine that anyone can produce by throwing some seeds on a bare patch of ground. It has to come from immensely expensive, slow, lengthy projects that cost billions and result in patented products that are only available from a few point sources, typically at a back-breaking cost per dose. Big energy cannot provide energy that comes directly from the sun and is captured cheaply by simple apparatus that anyone can own. It has to come from a few point sources halfway around the world, after bloody struggles costing trillions."

Review of Happy Accidents: Serendipity in Modern Medical Breakthroughs by Morton A. Meyers

Our friend Taleb strongly recommended reading Happy Accidents: Serendipity in Modern Medical Breakthroughs by SUNY radiologist Morton Meyers:

"[A] controlled experiment can easily show absence of design in medical research: you compare the results of top-down directed research to randomly generated discoveries. Well, the U.S. government provides us with the perfect experiment for that: the National Cancer Institute that came out of the Nixon 'war on cancer' in the early 1970s.

'Despite the Herculean effort and enormous expense, only a few drugs for the treatment of cancer were found through NCI's centrally directed, targeted program. Over a twenty-year period of screening more than 144,000 plant extracts, representing about 15,000 species, not a single plant-based anticancer drug reached approved status. This failure stands in stark contrast to the discovery in the late 1950s of a major group of plant-derived cancer drugs, the Vinca Alcaloids -a discovery that came about by chance, not through directed research.'"

The point of Meyers' book is that almost none of the dozens of most important medical breakthroughs over the past century or so, especially in pharmaceuticals, would have been found by the current medical research system. Huge projects with NIH or other government funding are not what led to breakthrough discoveries. Physicians and scientists tinkering with accidental (serendipitous) discoveries is what has led to breakthroughs. Taleb sees a pattern in the researchers' stories:

• The discoverer is almost always treated like an idiot by his colleagues. Meyers describes the vicious side effect of "peer reviewing".
• Often people see the result but cannot connect the dots (researchers are autistic in their own way).
• The members of the guild gives the researcher a hard time for not coming from their union. Pasteur was a chemist not a doctor/biologist.
• Many of the results are initially discovered by an academic researchers who neglects the consequences because it is not his job.

Besides the National Cancer Institute that Taleb mentioned in his review, China is a good example of the failure of top-down research and over-organization. As was discussed in our review of The Party, the Chinese "elite consumes all of the potentially productive capital that innovators might otherwise use to create additional capital. So China's list of inventions is paltry."

The other key insight from the book, which is sort of tangential to his thesis, is that medical discoveries are incredibly slow to be put into practice. Ignaz Semmelweis discovered in 1847 that medical students in Vienna were killing women with puerperal fever by conducting autopsies and then examining patients without washing their hands. Doctors were offended and it took decades for them to finally wash their hands.

There are some things I've read over the past several years that still aren't widely known. For example, while cholesterol levels too high may be bad, the optimal cholesterol is not zero, and it is higher than people think. There is a U-shaped curve where high cholesterol has the well-known cardiovascular effects, but low cholesterol leads to depression and suicide.

Another interesting one is that lithium levels in municipal drinking water are inversely associated with suicide. Note that lithium for mania is one of the breakthroughs in Meyers' book, and he writes that "another factor contributing to slow development of lithium therapy was the lack of commercial interest by pharmaceutical companies in this inexpensive, unpatentable mineral."

I wonder if there are all kinds of mineral deficiencies in the population, because there's something similar occurring with magnesium. This recent paper says that there is "more than sufficient evidence to implicate inadequate dietary magnesium as the main cause of treatment resistant depression, and that physicians should prescribe magnesium for treatment resistant depression". See also this Evolutionary Psychiatry post where she says that the Mg case studies remind her of "old fashioned papers, such as [the] one by John Cade about the use of lithium in mania."

She says that "there is a woeful lack of well-designed, decent-sized randomized controlled trials of various psychiatric disorders and magnesium supplementation." This is because there is no vig for anyone in increasing dietary Mg, and in fact it would torpedo the sales of the big pharma lucrative antidepressants if it works as advocates suspect it does.

I give this a 3/5 in that I wouldn't need to reread it again, but I agree 100% with Meyers' thesis.

Standard General Files Radio Shack Schedule 13D $RSH

This was filed today by hedge fund "Standard General",

This Schedule 13D is being filed on behalf of (i) Standard General L.P., a Delaware limited partnership (“Standard General”); (ii) Standard General Master Fund L.P., a Cayman Islands limited partnership (the “Master Fund”); (iii) Standard General OC Master Fund L.P., a Cayman Islands limited partnership (the “OC Master Fund”); (iv) P Standard General Ltd., a British Virgin Islands business company (“P Standard General”); (v) Standard General Focus Fund L.P., a Delaware limited partnership (the “Standard Focus Fund” and, together with the Master Fund, the OC Master Fund and P Standard General, the “Funds”); and (vi) Soohyung Kim (“Mr. Kim”), a director of the general partner of the general partner of Standard General. The persons and entities referred to in items (i)-(vi) hereof may be collectively referred to herein as the “Reporting Persons.” [...]

Standard General has been in discussions with the Company regarding a proposal on a business operating plan and certain ways to improve the Company’s liquidity position in advance of the holiday shopping season. Proposals under discussion include Standard General and certain other investors (the “New Investors”) purchasing loans and other commitments under the Company’s asset backed credit facility (the “Credit Facility”) from its existing lenders. Under such a proposed transaction, Standard General and certain other New Investors may propose to subordinate their investment in the Credit Facility to other investors in order to improve the near-term liquidity available to fund the Company’s holiday working capital needs. Pursuant to such a proposal, the investment by the New Investors could be the first step of a broader recapitalization of RadioShack proposed to be completed by early 2015, which may include Standard General and certain other New Investors acquiring preferred equity convertible into common equity, board nomination rights and corresponding changes to the Company’s structure. The New Investors have provided draft financing commitments to the Company to fund such a transaction. Discussions are ongoing among the Company, the New Investors, and the existing lenders under the Credit Facility. No assurances can be given that the proposed transaction will occur, or in the form currently under discussion.

The Reporting Persons reserve the right to change their purpose and to formulate and implement plans or proposals with respect to the Company at any time and from time to time. Any such action may be made by the Reporting Persons alone or in conjunction with other shareholders, potential acquirers, financing sources and/or other third parties and could include one or more purposes, plans or proposals that relate to or would result in actions required to be reported herein in accordance with Item 4 of Schedule 13D.

The Reporting Persons hold options to acquire an aggregate of 3,000,000 shares of Common Stock at a price of $1.50 per share, which options expire in January 2016. Standard General has entered into a confidentiality and standstill agreement with the Company. Pursuant to this agreement, Standard General has agreed that until June 12, 2015, neither it nor its affiliates will propose (except in the context of consensual negotiations) any acquisition, restructuring, recapitalization or certain other transactions relating to the Company or its affiliates, or engage in certain other activities relating to an effort to obtain control of or influence over the Company’s management, Board of Directors or policies.

Murray Comments on Coal Industry

Murray also scoffed at claims from some coal companies that they are reducing costs to compete during the downturn. Murray did not name any specific coal producers.

"These coal companies are telling you, 'Well, we're reducing our costs to compete in this bad market.' Hey, bankruptcy coming!" he said. "Because in the coal business, you already had your costs as low as you could possibly make them every day. That is garbage from public coal companies who are worried about their stock price. Be alerted."

Dividends and Share Repurchases When Companies Are Approaching Insolvency

Here's an interesting subject for distressed investors to think about: the legal boundaries regarding dividends and share repurchases when a company is approaching insolvency.

One good paper is "Wrongful Corporate Cash Distributions Under Delaware and Georgia Law" [pdf]. Some highlights:

A Summary of the Key Formula
Title 8, sections 160 and 170 of the Delaware code allow a corporation to purchase its own stock or issue dividends, provided that such transactions do not result in an impairment of the corporation’s capital. If the amount calculated is less than the amount distributed, then the transaction is unlawful, and directors who willfully or negligently conducted the unlawful redemption are jointly and severally liable. Del. Code, tit. 8, §§ 160, 174.[...]

Section 174 of the General Corporation Law makes directors personally liable for their willful or negligent conduct in connect ion with the repurchase of stock or the payment of an unlawful dividend. The director s are liable to the corporation, and in the event of dissolution or insolvency, to its creditors, at any time within six years from the date of the unlawful stock repurchase or the payment of the unlawful dividend, for the full amount of the payment. However, Sections 141(e) and 172 of the General Corporation Law provide protection to directors who in good faith rely on the books of the corporation or on reports of officers or outside experts selected with reasonable care in determining whether there are sufficient funds legally available for a stock repurchase or payment of a dividend. [...]

The purpose of the limitations on the sources of funds for effecting valid stock repurchases contained in Section 160 and permissible dividends contained in Section 170 are to protect creditors (and in some cases stockholders as well) from fraud. Therefore, it appears that the reference to 'value' in Morris must be read as a reference to fair market value of assets and liabilities because it is only fair market value that represents a potential fund from which creditors' claims may be satisfied.

This article points out some other potential causes of action if directors or management improperly deprive creditors of value through dividends or share repurchases: breach of fiduciary duty, fraudulent conveyance, and state law provisions such as Section 14-2-640 of the Georgia Business Corporations Code.

Another good article is "American Corporate Law: Directors' Fiduciary Duties and Liability during Solvency, Insolvency and Bankruptcy in Public Corporations" [pdf]:

"A check-list for [corporate directors to avoid] personal liability to creditors for their actions when the corporation is or may be in the zone of insolvency includes: [...] Consider retaining financial advisors to evaluate whether contemplated transactions are fair to the creditors of the corporation; [...] Assure that decisions are defensible on the basis of good faith judgment - generally, it is prudent to avoid dividends or stock redemption while in the zone of insolvency; Be prepared to demonstrate, based on reports and outside advisors, reflected in the records of the board's deliberations, that any awards of executive compensation were reasonable and necessary..."

Last article worth mentioning is "Protecting Directors and Officers of Corporations That Are Insolvent or in the Zone or Vicinity of Insolvency: Important Considerations, Practical Solutions" [pdf]:

"[C]ourts may judge in hindsight whether the corporation was insolvent at the time that the corporate decision in question was made, 'notwithstanding contrary presentations made in the company's audited financial statements or made to its board of directors.' Accordingly, it is prudent for directors and officers to adopt a conservative approach in their evaluation of the corporation's solvency and to assume that the corporation is insolvent or within the zone of insolvency if there is any reasonable question about the corporation’s solvency."

These rules for directors to follow result in two important signals of corporate insolvency: ceasing dividends and hiring financial advisors. Debtwire is a subscription service that costs a fortune but delivers valuable scoops about what companies have hired restructuring advisors or counsel; investors then know to unload those companies shares.

WSJ: "Climate Science Is Not Settled"

Article by Steven E. Koonin:

"For the latest IPCC report (September 2013), its Working Group I, which focuses on physical science, uses an ensemble of some 55 different models. Although most of these models are tuned to reproduce the gross features of the Earth's climate, the marked differences in their details and projections reflect all of the limitations that I have described. For example:

• The models differ in their descriptions of the past century's global average surface temperature by more than three times the entire warming recorded during that time. Such mismatches are also present in many other basic climate factors, including rainfall, which is fundamental to the atmosphere's energy balance. As a result, the models give widely varying descriptions of the climate's inner workings. Since they disagree so markedly, no more than one of them can be right.

• Although the Earth's average surface temperature rose sharply by 0.9 degree Fahrenheit during the last quarter of the 20th century, it has increased much more slowly for the past 16 years, even as the human contribution to atmospheric carbon dioxide has risen by some 25%. This surprising fact demonstrates directly that natural influences and variability are powerful enough to counteract the present warming influence exerted by human activity. Yet the models famously fail to capture this slowing in the temperature rise."

Global warming was a promising hoax; luckily it's as dead as a doornail. The elites were scheming to impose an awful taxation and regulation tyranny based on this theory.

"Walter Energy's bonds lose $363 million on coal woes" $WLT

Latest,

"I don't think they last until 2016," Charles Johnston, a New York-based coal analyst at CreditSights Inc., said in a telephone interview. "They have a limited amount of time until they run out of cash."

Walter management made a huge mistake by not exchanging more of the unsecured debt for equity when the equity was trading at much higher prices.

Update: "Hussman's Ratio" of Margin Debt to Commercial and Industrial Loans

I've posted several times before [1,2,3] about "Hussman's Ratio" of Margin Debt to Commercial and Industrial Loans, after he pointed out in December 2013 that,

"the amount being borrowed to buy stocks on margin is now 26% the size of all commercial and industrial loans in the entire U.S. banking sector."

Here is what the ratio looks like now:

The ratio spent much of the second half of the 20th century below five percent. It was not until the Fed induced bubble in the mid-1990s that it went parabolic, cracking 15% for the first time ever in September 1997.

Here are all the months when the ratio has been above 25 percent: February and March 2000; April through August 2007; February through May 2011; April 2013; and September 2013 through August 2014. The most recent stretch, at twelve consecutive months, is by far the longest ever. With the exception of the most recent (which remains to be seen), these were the worst possible times to buy stocks.

Keep in mind that we are deflating the margin debt series using commercial and industrial loans, which grow very swiftly themselves during credit bubbles.

By the way, here are the months where this series hit a local minimum: July 2012, February 2009, October 2002, October 1998, January 1991, September 1982, January 1975, October 1970.

Here is something that I'm noticing on my fourth look at the time series of this ratio: the oscillations are getting bigger. Granted, it's not a very big sample size, but the 2007-2009 peak-to-trough was bigger than the 2000-2002 peak-to-trough.

Long Bond Back in Uptrend?

Review of Oil Notes by Rick Bass

I was expecting Oil Notes by former petroleum geologist Rick Bass to be a great little read, but the new introduction in the second, 2012 edition revealed that it was going to be a disappointment.

What kind of petroleum geologist refers to our fossil fuel bounty as "dirty carbon"? Or moans about oil spills like Deepwater Horizon (a rare accident) becoming frequent occurrences that will "disturb our blithe innocence" if we "continue drilling at such absurd depths"? He quotes Obama's admonishment that "as a nation we have to grow up now".

This reminds me of another terrible petroleum history book, Petrolia, where I had to remind the author that fossil fuels liberated humanity from darkness and manual labor.

The original edition was published in 1989, and some of it was worthwhile:

"This is a thing oilmen (masc. and gem.) do: they put oil in sample jars, little solid glass cups with screw-on caps. You can unscrew the cap and smell it. [...] When no one else is in the office, put the cap back on and hold the bottle up to your ear. Picture an ancient seashore. A world so different from the one we are in now it is frightening."

I guess it says a lot that he was politically correct in 1989.

He was a development geologist, who worked to define the boundaries of a discovered field, as opposed to an exploration geologist looking for previously unknown oil.

Says he doesn't know or care much about leases, that the land aspect is boring to a geologist. Yeah right. I'm curious how oil companies know about or prevent their employees' cousins from leasing land in a hot new play.

I would guess that as Bass became a novelist, he thought he was leaving "dirty carbon" behind.

2/5

"The Banker Who Said No"

Classic article

Beal plays his cards patiently. For three long years, from 2004 to 2007, he virtually stopped making or buying loans. While the credit markets were roaring and lenders were raking in billions, Beal shrank his bank’s assets because he thought the loans were going to blow up. He cut his staff in half and killed time playing backgammon or racing cars. He took long lunches with friends, carping to them about “stupid loans.” His odd behavior puzzled regulators, credit agencies and even his own board. They wondered why he was seemingly shutting the bank down, resisting the huge profits the nation’s big banks were making. One director asked him: “Are we a dinosaur?”

Now, while many of those banks struggle to dig out from under a mountain of bad debt, Beal is acquiring assets.

Skeptics To The Ramparts: How Bull Markets Are Formed From The "Prince Racquet" Effect Until The Momentum Favorites Get Tired

A correspondent writes in,

My good friend CP and I spend a great deal of time discussing the problem that we share as two cynical contrarians, namely how to restrain our bearish enthusiasms in the face of investor euphoria and avoid the performance killer of being early. Valuation metrics don't help the timing problem. Witness the plight of that analytical genius John Hussman who keeps losing his clients money in his growth fund as overvaluation continues and increases for years on end. Similarly, the standard sentiment measures like Investors Intelligence, Market Vane and AAII measures of optimism hit extremes many times during a prolonged market rise. They may increase the odds for a short side swing trade for 5 days or perhaps 3 weeks, but the false positives for a full fledged bear market are too numerous. Who can forget the glaring signs of impending doom back in mid 2007 and the painful wait for a year and a half until September of 2008?

What we need is a sentiment indicator that has merit for longer term bear trades – one that keeps us long during periods of delusional optimism and urges us to exit just before the inevitable peak and endure only a several month wait until the bear attacks. We want an indicator that will allow us to gloat and quickly double our fortunes by being short at the right times and then go long and snooze for 4 or 5 years as the selling climax reverses and we go long the new momentum favorites.

CP likes those distressed debt trades where the bonds are selling at 60 cents on the dollar indicating bankruptcy is inevitable while the stock investors think the common stock still has value. These are good trades, and yet I and most other bearish investors have weaker egos that need the satisfaction of seeing the mighty fallen and the massive hordes of hipsters and momentum stock fanboys humbled. And more important, you make the most money staying with momentum stocks long, and shorting at the right time. And for that we need a sentiment indicator that is relevant to the dominant psychological driver of market euphoria. I have a theory that bull markets are created and maintained not by valuation but by momentum and herding.

As a young man and a new associate at the largest law firm in the state in 1974, I began playing tennis (not too aggressively) with some of the partners and discovered that they all had purchased aluminum racquets with the ugly, oversized head and striking surface from a company called Prince Racquet. Being a stock market investor at the time I looked up the company and found that it had an astronomic PE multiple (by 1970s standards) and I knew that the stock would plunge back to earth once sales slowed. Thereafter I noticed that stocks that produced whatever new gadget, fad or thing that filled the yuppie's hands tended to fly to the moon. I called it the Prince Racquet effect, a syndrome which tends to produce momentum surges beyond all reason. It drove Microsoft in 1995 (windows 95) and it now drives Starbucks, Apple, Google, Amazon, Netflix, Facebook, Twitter, Priceline, Chipotle Mexican Grill, and every other provider of things and services that fill hipster and yuppie hands or engages their eyes and fingers, or occasionally exploits their hopes for eco-nirvana as in the case of Tesla motors.

The Prince Racquet effect has always informed my short sale preferences. Thus I am now entirely reliant on my young adult daughters to tell me what is new and hip. And I must say that the Prince Racquet effect has gained considerably more power now than it had pre-1990. Items which fill the hipster-yuppy hand are now not merely fads, but are essential emblems of identity and recognition for the increasingly atomized, anonymous and disconnected individuals of today, herded by what they hold in their hands and use in their lives.

So then here is the candidate for the one reliable sentiment indicator - one which does not involve opinion surveys but relies on actual money flows into the Prince Racquet effect stocks.

I think that when you see momentum loss on the weekly charts of the most talked about moment stocks – the fad stocks and cocktail stocks that are most susceptible to investor herding - you have reason to go to cash and wait for THE TOP. And when I say momentum loss I mean a lower high on the weekly MACD even as price may still be rising. Click on the links for the following momentum favorites that are losing their mojo:

AAPL
GOOG
AMZN
NFLX
SBUX
PCLN
FB
TSLA

and one daily chart of a new entry, TWTR, consistent with the above but lacking the weekly time discipline.

It is one thing for a single company to fall from grace due to a company specific problem, but when you get a cluster of decade long momentum favorites getting tired at the same time the odds on bet is to sell all your long positions and begin nibbling at the short side to make sure you stay awake while stalking the big cahuna to the downside. My suspicion is that the value of or productivity of advertising is beginning to fall and all of the search and social media stocks will fall as ad revenue declines in response to decining productivity of those ads to retail sellers. Also, I think that a company like PCLN will get clobbered from both sides as fewer travel bookings are made by consumers and businesses tightening their belts and by fewer airlines and venues offering discounts as they struggle to maximize full price revenue from those who can still afford to travel. And for all its profitless sex appeal, AMZN is, after all, still just a retailer. For those of you who like busted “redneck” momentum stocks, I would invite you to plug the symbol RGR and SWHC. And for those of you betting on the momentum favorites among the “rising poverty stocks” plug in DLTR and ROST

Skeptics to the ramparts!!

By the way, last week Prechter put out a one page bulletin saying simply: "THIS IS IT".

Stockman: "They Do Ring A Bell At The Top: Alibaba Proves Wall Street Is Off Its Rocker"

Hilarious:

"before the day was over it was trading at 27X the LTM sales posted for a shell in the Cayman Islands—-an entity on the word processor of a law office located there which may or may not receive actual cash dividends and honest accounting statements from a myriad of entities that do countless things in China."

Story: "RadioShack in Talks With Supplier to Ease Restructuring" $RSH

The story:

"RadioShack, the electronics retailer trying to avoid bankruptcy, said it's holding talks with a 'major vendor' that could help the company restructure its finances.

The negotiations involve some of RadioShack's largest creditors, the Fort Worth, Texas-based company said today in a regulatory filing. While no agreement has been reached, the talks are continuing, the retailer said.

'The company continues to explore how to optimize its various commercial relationships,' RadioShack said. 'There can be no assurances that any such discussions will result in modifications to the company’s commercial arrangements.'

'I take this as a very bad sign,' Anthony Chukumba, an analyst at BB&T Capital Markets in New York, said today in an interview. 'They said, 'We want better terms so we don’t have to go bankrupt,' and the vendor said no.'

Video: " From the 2014 iProspect Client Summit: RadioShack Brand Spotlight with Amy Shineman" $RSH

Radio Shack SG&A: Who Is At Corporate?

I was just curious about Radio Shack's SG&A at corporate and also what kind of people they hired in 2013 for the "turnaround". These are people whose LNKD pages list them as active RSH corporate employees.

• CEO Joe Magnacca.
• CFO John W. Feray - note that he just resigned and was replaced by someone from restructuring firm AlixPartners.
• Paul Rutenis, Chief Merchandise Officer
• Michael De Fazio, Vice President of Store Operations
• Bruce Bishop, Vice President, Corporate Financial Planning & Analysis and Investor Relations ("Reporting to the CFO and leading a team of 10.")
• Kathy Buckley, VP Finance, Retail Operations
• Jennifer Warren, Chief Marketing Officer. 
• Camp Rollings, "Director - Marketing Strategy"
• Mindy Davis, "Director of Integrated Marketing" 
• Misty Allen, "Director, Online Experience and Design"
• Amy Shineman, "Senior Director, Integrated Marketing". Here's a great video where she talks about the decision to buy the "super bowl" ad.
• Lauren Kushnerick, "Integrated Marketing Manager"
• Merianne Roth, "Vice President of Communications"
• Renee Adams, "Director of CRM"
• Troy Risch, Executive Vice President Operations and Real Estate
• DeAnna Alexander, Director, Finance at RadioShack
• Macy Moore, "Director, Web Operations"
• Denise Levesque, Vice President, Regional Operation
• Michael Casey, Vice President Merchandise Planning & Allcoation at RadioShack 
• Donna Butler, Director, Merchandise Planning & Allocation Operations
• Jim Loden, Vice President of Dealer Franchise Stores and B2B Sales and Operations
• Benny Benoit, VP, Supply Chain Operations
• Sammy Saloum, Vice president, Business Development
• Troy Risch, Executive Vice President Operations and Real Estate - he left in April and went to hhgregg
• Michael Keyser, VP Merchandise Operations
• Sri Reddy, VP Omnichannel

That's not even counting all of the regional managers and so forth of the actual stores; this is just some of the corporate overhead. One thing that stands out is that they have a ton of people with experience at places like Zale, drugstores, Blockbuster, fast casual dining, Target, but no one whose background seems really consistent with the DIY turnaround.

It seems like a huge payroll and it also seems like some of the roles are overlapping and ambiguous.

It will be interesting to watch these people and see if more of them jump ship.

Radio Shack: What Could Have Been, And What Will Be

It's too bad about Radio Shack fading out. I remember going there when I was a kid, curious about the offerings and looking at things to tinker with. But it's not a good way to distribute cell phones or consumer electronics, and it will ultimately be for the best for the time and resources currently being wasted in the business to be repurposed.

Like most managements, they had absolutely no idea what to do when their business model started to falter. Companies with an unclear future should not have any debt, yet the company borrowed very expensive money over the past several years.

Let's assume I'd been in charge starting June 2012 (the stock was in the $4s), right after they paid their last dividend. Here's what I would have done:

• swap the unsecured bonds for stock
• sell additional equity to pay off the secured debt
• cut capital expenditures to the bare minimum - no store redesigns
• cut SG&A, starting with the seven vice presidents
• cut marketing - no "super bowl" ads

I would not have tried to "pivot" to a new merchandise mix or business model. I don't think there is one that can work; they are the worst, highest cost provider of all of their different product segments.

I would have closed stores as they became unprofitable. I would've looked for opportunities to assign store leases that were in the money if the stores were only modestly profitable.

I would've been honest with investors that the business was in runoff mode. Liquidating stores would have generated cash. It's possible that the honest, pessimistic approach would have caused the stock to be cheap. If so I would have repurchased shares. If shares were expensive, I would have issued more and bought shares of banks trading at huge discounts to book value. Could've been a Berkshire.

Anyway, management basically did the opposite of my plan. So now there are only two possible scenarios, one of which is going to occur in short order: either they file for bankruptcy protection or they get a generous "rescue financing" that lends them more cash and would probably be tantamount to a bankruptcy in terms of the dilution (like the Molycorp financing, but worse). Even all the sell side people admit these are the only two scenarios.

The question is: how do the bonds and stock each move from their current prices in these scenarios?

In the bankruptcy scenario, the stock obviously trades way down, lower than the August low of 55 cents. It would easily fall 75% from the current price, I think, and would ultimately get zero. The bond price change is much tougher to ascertain. The bonds don't price in as much optimism as the equity does - they assume a significant amount more cash burn. I could see them reflexively trading down 10 points, or a 33% loss in value.

In the rescue scenario, the bonds get a big boost. Any money coming into the company is going to pay unsecured coupons for a while, and the bonds would trade down from the 20% current yield I think. Also, the rescue is basically pointless if the unsecureds don't get paid at maturity, so there would probably be some provision in the rescue package for taking care of the bondholders. Honestly, a rescue would be so needlessly good for the unsecureds that I can't really see it happening. If you wanted to invest in Radio Shack it would make a lot more sense to take it through bankruptcy so that you could reject store leases and haircut the unsecureds.

It's less clear what happens to the stock in the rescue scenario. (We live in such a bailout culture now.) The kneejerk response is that it's bullish because it keeps the company and equity alive. However, anyone making a rescue loan would be insane not to negotiate all of this upside for themselves by demanding tons of stock or warrants. And there would probably be a second round of dilution because you'd want to insist that the company do an exchange offer for the bonds so that cash wouldn't be wasted on interest payments. (That's why I said 'tantamount to a restructuring'.)

So in the two scenarios, which cover the vast majority of the probability space (otherwise you need a sales and cash flow recovery in the business), the bonds seem likely to outperform the stock.

One other important Radio Shack topic for today is the liquidation value of the inventory. Read this excellent post about how the liquidators Hilco/Gordon Bros do retail liquidations:

Knowing that there’s a possibility that the physical inventory count could come up slightly different from the ‘book’ numbers – apparently estimated at about to $350M as of last week’s purchase - Hilco/Gordon expressed their bid in a way that mathematically came to their $250M bid: ‘72% of inventory at cost’ ($250M/$350M). If there turned out to be more or less inventory for whatever reason, they could adjust the purchase on that basis

That ‘72% of cost’ rate was about what Hilco/Gordon paid for the Best Buy inventory; for Linens they paid about 95% of cost – suggesting perhaps a combination of (a) higher markup in the Linens inventory, and (b) an expectation that it would require less discounting to move it. Remembering that Gordon Bros has been around for a century, we can assume they have a pretty solid handle on their estimations.

With almost 400 stores Borders – like Linens N Things- is a big job. Earlier in this thread competitors in the industry – other liquidators – were identified as including SB (Schottenstein’s firm), Tiger, Hudson, Great American, and possibly Monarch (more a focus on distressed debt than actual liquidation).

For Linens, Hilco / Gordon enlisted pretty much the entire field of smaller ‘competitors’, farming out portions of the job to SB, Great American, Tiger and Hudson. For Borders, Hilco/Gordon brought all but Hudson back in for pieces (instead, Hudson’s founder returned to work at Gordon Bros). At the top levels, the industry is fairly incestuous – Hilco, Tiger, and Hudson were all founded by, or run by, Gordon Bros execs, and those firms get a fair portion of work from the pair.

Radio Shack inventory in general has high markups (34% gross margin), which is bullish for the liquidation realized values. And I would guess that a large dollar amount of inventory is newer stuff that could be liquidated above cost pretty easily.

Millard Drexler: "Surround Yourself With People That Get It"

I posted a Mickey talk from April this year. This one was actually earlier, a couple years ago:



He's a character.

Nothing New From Radio Shack

No "rescue financing" package. The bonds ended the week at 35. I would think they'd be getting bid up if this was going to end in something besides a bankruptcy.

NII Holdings Notice of Delisting $NIHD

This is the end of the road for the equity:

On September 16, 2014, NII Holdings, Inc. (the “Company”) received a notice (the “Notice”) from the staff (the “Staff”) of The NASDAQ Stock Market LLC (“NASDAQ”) indicating that the Staff intends to delist the Company’s securities from The NASDAQ Stock Market. The Notice was issued in accordance with NASDAQ Listing Rules 5101, 5110(b) and IM-5101-1 and states that the Staff’s determination is based on the Company’s announcement that it had filed for protection under chapter 11 of the U.S. Bankruptcy Code and the associated public interest concerns raised by the filing, concerns regarding the residual equity interest of the existing listed securities holders, and concerns about the Company’s ability to sustain compliance with all requirements for continued listing on The NASDAQ Stock Market, including in particular Listing Rule 5450(a)(1), which requires a minimum bid price of $1 per share.

The Notice states that, unless the Company requests an appeal of the determination, trading of the Company’s common stock will be suspended at the opening of business on September 25, 2014 and a Form 25-NSE will be filed with the Securities and Exchange Commission, which will remove the Company’s securities from listing and registration on The NASDAQ Stock Market. The Company currently anticipates that any plan of reorganization implemented in the bankruptcy proceeding would provide that holders of claims and interests with respect to its equity securities, or rights to acquire its equity securities, would be entitled to no recovery and that those claims and interests would be canceled for no consideration. If that were to occur, all of the value of investments in the Company’s common stock will be lost. For this reason, the Company does not intend to take any further action to appeal the Staff’s decision.

Gundlach: "What Happened to 10-year U.S. Treasury Rates During the 2004-2006 Rate Hike Cycle"

Wonderful.

The Broken Silver Parabola

I was right about the silver bubble.

Now looks like another very good risk reward for being short. The "support" at around $18 has been broken. My target to the downside would be and has been marginal cost of mining.

See the latest Pan American Silver investor presentations, for example. Based on the chart above, the production growth despite declining prices, and the mines' cash costs, $10 per ounce sounds about right.

Ackerman: "Strong Dollar Augurs Even Lower Rates"

"the recovery is so weak that even a small upward shift in rates would put the U.S. on the same recessionary track as Europe"

"Judge Approves NII's First-Day Bankruptcy Court Requests" $NIHD

WSJ

"NII said at the time that it would continue negotiating a restructuring with the bondholders up until the deadline, which was this week. Last week, NII announced those discussions hadn't produced an agreement on restructuring. The company has two main groups of creditors, one led by Aurelius Capital Management LP."

"Aurelius Supports NII’s Swift Emergence from Chapter 11" $NIHD

Press release from NIHD bondholder Aurelius

We have taken the lead among bondholders in supporting a plan that would allow the Company to emerge from Chapter 11 swiftly, by deferring until after emergence the resolution (through litigation or settlement) of many inter-creditor disputes. Aurelius was ready last week to enter into a binding agreement to support a plan (the “Reserve Plan”) that would have:
Converted all $4.35 billion of NII bonds into 100% of the reorganized company’s equity (before taking into account the rights offering mentioned below and any management incentive plan).
Allocated that equity among the bondholders in accordance with the absolute-priority rule.
Raised fresh equity through a rights offering. Aurelius offered to backstop $125 million of that rights offering.
Deferred all inter-creditor disputes until after NII emerges from Chapter 11. A portion of the new equity would be placed in reserve and released as each dispute is resolved, whether through litigation or settlement. (Any settlements reached before emergence would be taken into account in the initial distribution of shares at emergence.)

"For RadioShack, a History of Misses" $RSH

NYT

"The big box stores like Best Buy began to capture the bulk of the electronics business. RadioShack remained largely your local stop for electronics gear. The problem was that most of the equipment became cables and ancillary things to make the computers go.

Looking yet again for a new business model, RadioShack seized on mobile. But this merely made RadioShack a pawn in the cellphone wars as it tried to profit from selling a commodity."

"Execs Leave Cash Behind in Bolting RadioShack" $RSH

"Newly departed RadioShack CFO John Feray is far from the first executive to leave lately--and it cost him. Just like it did Troy Risch, RSH's former store-operations executive. He left in April for a job at furniture and appliance store Hhgregg. Both forgoed a $275K retention bonus on top of regular salary and performance pay the company promised if Feray and Risch stuck around until March 2015."

Manuel Cardoso: Lamentatio

NII Holdings Hitting New Low $NIHD

I always like to see who is still holding this type of company when D-Day arrives. (Maybe some of them sold since June 30.)

WSJ: "Venture Capitalist Sounds Alarm on Startup Investing"

This WSJ interview is with Bill Gurley, venture capitalist and author of Above the Crowd:

"For the first time since '99, in the past 12 months, I've been in board meetings where the company says, 'Our only option is a 10-year lease,' at record pricing on a per square foot basis here in San Francisco, which is two or three times what the rent was three years ago. And so this is why it's all cyclical—because the landlords get greedy. They wouldn't do a 10-year lease if they thought that the rates were low. So they're implicitly telling you they want to lock this in for 10 years, which is its own form of greed because what happened in '99 is half the companies went bankrupt and they couldn't pay the lease over the 10-year period."

That is an excellent observation. Also notable is that Gurley himself (essentially) says that even he is unable to stop investing and his portfolio companies are unable to spend more conservatively.

"RadioShack CFO resigns; AlixPartners MD named interim CFO" $RSH

Story

"The company said on Monday it named AlixPartners LLP managing director Holly Etlin as interim CFO. Advisory firm AlixPartners has been helping RadioShack with its turnaround since July 2013. Feray, who joined in February from Dollar General Corp , resigned on Sept. 12 citing personal reasons, RadioShack said in a statement."

"NII Holdings Files Bankruptcy as Users Seek Faster Phones" $NIHD

"The case is NII Holdings Inc., 14-12611, U.S. Bankruptcy Court, Southern District of New York (Manhattan)."

Schwarzwalduhr

SFB Bancorp, Inc. Call Report For Q2 2014 $SFBK

Wrote about SFBK in July - a small community bank in eastern Tennessee. At the current market price of $23, that is a market capitalization of $8.8 million. At year end 2013, the book value of the company (assets minus all liabilities) was $13,892,000. That was $36.26 per share.

The company does not file reports with the SEC and does not send quarterly reports to shareholders (just an annual report). However, we can obtain an FDIC report ("call report") showing the quarterly results of the company's regulated bank subsidiary. For the first quarter of 2014, net income was $136,000, up from $120,000 in the first quarter of 2013. According to the Q2 call report, net income was $155,000 compared with $175,000 the prior year.

Book value of the bank should now be about $37 per share. The price-to-book is still about 62%. The annualized return on equity right now is an anemic 4.2%. Factoring in the discount to book value, you are earning about 6.8% (earnings yield).

Assets almost unchanged year over year, at $56 million. Loans are also roughly unchanged at $38 million. However, a significant amount of cash was shifted from interest bearing deposits to the available-for-sale securities portfolio. The biggest increase was $5 million in munis. SFBK likes the same muni trade that I do! And they were buying in the 5-15 year duration bucket, the same part of the curve that I have liked!

There's been an uptick in past due and nonaccrual loans year over year. If management has reserved properly, then this should already be reflected in the financial statements. I would not ordinarily give a bank management that much credit, however management seems to make conservative loans, judging by the profitable years during the housing crash and also by investments in munis at the top of the economic cycle instead of growing the loan portfolio.

"RadioShack's Pathetic Spin Attempt in the Fine Print" $RSH

Herb Greenberg post about the Radio Shack Q:

Shame on RadioShack  (RSH) for leaving the best part for the fine print that most people probably would've missed.
To read the text of its earnings release today is to read about a company discussing "debt restructuring," closing stores and, in general, a "recapitalization." But, above all, it's a company discussing "a solution to maximize the value to all of our stakeholders"

To anybody who has been around the market for any amount of time, that should've set off bells and sirens.

"Recapitalization" is often a buzzword for bankruptcy, and the use of the word "stakeholders" should've been the dead giveaway.
But the company left the best part to the fine print of the liquidity section in its 10-Q, filed with the Securities and Exchange Commission. Here, RadioShack not only bluntly said that it's thinking about Chapter 11 bankruptcy, but that it is considering Chapter 7 liquidation.

More Details About the Molycorp Financing $MCP

A correspondent writes in about the details of the Molycorp financing, which have finally been disclosed:

The interest goes to 12% cash pay on 6/15/16 unless the 2016 notes have been paid off or exchanged for equity.

There are two springing maturity dates to make sure the 2016 and 2017 bonds don’t get paid off first.

There is a fairly ugly make whole on the term loan that starts at 43% of principal in year 1 and drops by 10% a year thereafter.

The lease agreement on the sale lease back is a 5 year full payout lease with a huge balloon payment in year 5.  Starts at 10MM in year 1 rises to 12MM in year 5 and has a 179MM payment at the end of the lease.  If the 2016 notes aren’t paid off on time, the lease payments shift forward by an undisclosed amount.

There is full ratchet anti dilution protection on the warrants in the first two years and weighted average protection in the last three years.

One final factoid, $27.5MM of the proceeds are going to buyback 2016 and 2017 notes held by Oaktree – they’ve got no interest in being exposed to the nether regions of the capital stack.

As I mentioned, the lenders also got $28 million in free warrants.

"B. Riley believes a meaningful recapitalization of RadioShack unlikely" $RSH

"B. Riley reiterates its sell rating and $0 price target on RadioShack and believes the likelihood of a cash infusion or meaningful recapitalization is unlikely. The analyst said Q2 results highlight ongoing cash burn and increased liquidity concerns..."

Baiju: "Unearthing China’s Ancient Terroir in Maotai" and Simultaneous Invention

About baiju, this article is more evidence that the "Chinese" are as different as different Europeans:

"In the centuries that followed, baijiu spread to all corners of the empire and became a fantastically diverse category of sprits. Because overland travel into the hinterland was often treacherous—if not impossible—each backwater hamlet developed production techniques in near total isolation. Some baijius are fermented in stone pots, others in vast subterranean pits of stone or mud. Most of them are distilled from sorghum but they can also be made from rice, wheat, corn, millet and even Job’s tears, or a combination thereof."

Also evidence of simultaneous invention.

Highlights From Radio Shack Conference Call $RSH

Nothing really useful in the conference call.

"Thank you. I would like to start today with an update on our balance sheet recapitalization work. I know that is foremost on people's minds, and then I will give you a brief status update on our efforts to turn the business around, and the associated work streams. And I will finish with a few comments on the upcoming holiday season.

It is clear that the current pace of our turnaround is simply not fast enough to address our near-term liquidity needs. This is a fact, despite the steady progress we are making with our strategic initiatives. Every day, we see consumers responding positively to the key elements of our turnaround strategy, such as the actions we have taken on reinvigorating our store experience, revamping our product assortment, and creating a stronger inventory position.

But we know we need additional financial flexibility to move ahead with our goals. As a result, we are actively exploring options for restructuring our balance sheet, and are in advanced discussions with a number of parties. We are in the process of working with our key financial stakeholders, including our existing lenders, bondholders, shareholders, and landlords, to create a long-term solution that would potentially involve a comprehensive recapitalization. [...]

Turning now to our mobility business, there are several factors that have been weighing against us. Soft consumer interest in the handsets currently available, aggressive price competition on these products, and intense wireless carrier marketing activities. The postpaid mobility business continued to be the primary driver of our sales decrease in the second quarter, as consumers anticipated this week's iconic handset launch, and have delayed purchasing or upgrading their phones. This in turn has led to further aggressive price competition on existing handsets among the wireless carriers and other retailers.

We have also not seen the full benefit of new carrier financing programs, which were only available in our stores for a portion of the quarter. These new financing programs are starting to gain momentum. We will continue to build awareness with consumers that we offer these options. Meanwhile, the carriers continued their intense marketing activities, which included financial incentives to induce customers to switch carriers, in addition to new heavily-promoted financing programs."

They did not take questions.

Some Notes on Radio Shack Financial Statements $RSH

Looking at the balance sheet for this quarter, I notice that accounts payable fell from $242mm to $153 million, with accrued expenses staying the same. Inventory was down substantially, yet almost all the benefit of inventory liquidation went to reducing accounts payable. So I guess that's trade credit going away - vendors demanding cash for product.

Book value is now negative for the first time.

They spent $28 million in capex the first half of the year - could have bought back quite a lot of unsecured debt for that. It shows you (and I guess we've known for a long time) that they aren't going to try to carefully steward the resources.

I guess management decided they needed to try to demonstrate that Radio Shack business model can be fixed with judicious applications of remodel capex. It would be funny if they target their remaining advertising dollars to the areas where they have remodeled stores?

Speaking of trade credit, here's a sell side analyst comment on that topic:

"[T]o avoid bankruptcy, or even to orchestrate some sort of prepackaged bankruptcy,Radio Shack needs support from lenders, vendors, shareholders, and landlords. Before this can happen, the company needs to show stabilization, at a time that product cycles are going against it and the economy continues to challenge its core customer. We worry that in its current financial position, the company will struggle to get key product this holiday. For example, we struggle to see a scenario where RadioShack will get iPhone6... [U]ltimately, we believe that it will be tough to get inventory this holiday, as vendors are skittish about getting paid."

"S&P Downgrades RadioShack To CCC-, Outlook Negative" $RSH

S&P comments:

"RadioShack Inc. continued to exhaust considerable cash in the second quarter and announced that it will look to seek additional capital that may include some form of debt restructuring. We believe the company will default or restructure in some form that is tantamount to a default within the next six months."

Management's Discussion and Analysis of Radio Shack Results $RSH

From the 10-Q:

Overall, our second quarter performance was challenged by a continued weak industry-wide consumer electronics environment and a soft mobility market. This was most prevalent in our mobility business which was negatively impacted by (1) low consumer interest in the current postpaid and prepaid handset offerings, (2) customers choosing to wait for new iconic handsets expected to be launched this fall, and (3) aggressive price competition on the current handset choices. In addition, the wireless carriers heavily promoted significant cash incentives for customers to switch to their networks which gravitated customers to the carrier’s retail store. Late last year, the carriers introduced new handset financing programs that were originally offered only in the carrier’s retail store. While we have since completed the process to offer these financing programs in RadioShack stores, they were only available for a portion of the second quarter and we are working to build awareness with our customers that we now offer them. The retail platform, the other half of our business, was also down for the quarter, but much less than the mobility business. Importantly, we saw an improvement in the trend of retail product categories as we moved through the quarter, which was driven by new offerings in our stores with new services including our Fix It Here program, new categories such as digital fitness and better inventory positions for these items.

Sales in our mobil ity platform decreased 30.4 % to $ 309.7 million for the 13 weeks ended August 2, 2014 , when compared with $ 445.2 million for the 13 weeks ended August 3 , 2013. This sales decrease w as primarily driven by decreased sales in our postpaid wireless business due to intense wireless carrier promotional activities to motivate customers to switch networks , along with new device financing programs offered by the wireless carriers that were initially only available in the wireless carriers ’ stores. During the 13 weeks ended August 2, 2014 , we began offering the carrier financing programs. Comparable store sales in this platform decreased 29.8% for the 13 weeks ended August 2, 2014 , when compared with the comparable prior period .

Sales in our retail platform decreased 10.0 % to $ 298.1 million for the 13 weeks ended August 2, 2014 , compared with $ 331.1 million for the 13 weeks ended August 3, 2013 . Sales were negatively affected by decreased sales in many categori es including batteries , cordless phones , memory players, audio cables and AC adapters , which were partially positively offset by increased sales of music accessories, portable speakers and wellness products . Comparable store sales in this platform decreased 9.2% for the 13 weeks ended August 2, 2014 , when compared with the comparable prior period .

In a sense, Radio Shack went out of business years ago, but survived by pivoting to mobile phone sales and borrowing a lot of money. Now the mobile phone game has kind of come to an end - so much competition - and the interest on the borrowed money is tough to pay. (Let alone repaying that money rather than continually rolling the loans over.)

Interesting that the traditional Radio Shack electronics stuff - batteries, cordless phones, cables, adapters - aren't selling well either. I suppose that would be the Amazon competition that I always talk about.

The Beats speakers I think are kind of a fad - not something to build a business on. Overall, this quarter seems to reveal deep problems with the business model and product mix.

More From "Vienna Capitalist"

Another good post, about mining:

"According to Austrian Business Cycle Theory (ABCT), during a credit boom those sectors that are most removed from ultimate consumption benefit the most during a credit boom. Due to the long-term nature of these projects interest cost is a relevant cost component, which gets lowered during the boom and hence ignites heavy activity. Needles to say: these sectors also disproportionally fall during the slump.

Now, there are few things further removed from consumption than mining. The credit boom in this case is China’s lending binge and the most remote sector impacted by the binge is the mining industry, which provides the main input for all that steel that goes into the empty skyscrapers. And in Australia’s case the whole economy is a derivative of the mining boom. China is the main reason why there has not been a recession in Oz for the past 20 years – not some superior central bank management or 'growth model.'"

He's short AUD/USD.

Molycorp Announces Successful Closing of $400 Million Financing Arrangement $MCP

They really gave away the store to be able to borrow this new secured money!

"In connection with the financings, Molycorp issued to Oaktree warrants to purchase up to an aggregate of 24,477,395 shares of the Company's common stock. Warrants to purchase up to an aggregate of 18,358,019 shares of common stock have an exercise price of $0.01 per share, and warrants to purchase up to 6,119,340 shares of common stock have an exercise price of $2.04 per share."

The free shares are 7.5% of the company. That is $28 million in value today, just for the privilege of being able to borrow $250 million secured at 12%.

"Goldman Proclaims the End of the Iron Age"

Source:

"The iron ore price has just hit a new 5-year low and Goldman is out with a piece in which they conclude that the 'end of the iron age' is near. Goldman basically states that we are shifting from an under supply phase in iron ore (2004-2014) to an oversupply phase which can be expected to last at least a decade. This comes as a result of the huge lags between investment and production – classic 'Schweinezyklus.'"

Quoting the GS piece, this amazing tidbit:

"On a per capita basis, the average household in China is accumulating steel at a rate equivalent to the purchase of a new car every 8 months (without disposing of its older cars)."

The Vienna Capitalist has an interesting theory about the damage that the Chinese "stimulus" did in terms of malinvestment.

"iron ore mining investment has really taken-off after the financial crisis, i.e. after we have already had books touting the commodity (around August 2008 oil hit USD 150/barrel) supercycle for half a decade. I can only speculate about why this is the case – long lead time for mine investments play a role for sure – but I think it also has to do with the fact that China’s investment binge really got out of control as a result of their huge stimulus program during the financial crisis."

Everyone thinks that we're at a "permanently high plateau" but the next crash is going to be big.

Funny Comment About Alibaba IPO

"as a shareholder, you are not becoming part owner of Alibaba, the Chinese online merchandiser, but instead get a share of a shell entity (the Cayman Islands based variable interest entity) that controls the operating company through a legal agreement (that exists because the Chinese government treats it as such, for the moment)"

Hilarious! Some people never learn...

Radio Shack Quarterly Results $RSH

From the press release:

13 WEEKS ENDED AUGUST 2, 2014, SUMMARY
Total net sales and operating revenues were $673.8 million, compared to $861.4 million last year. Comparable store sales were down 20.0% driven by traffic declines and soft performance in the mobility business.
Consolidated gross profit was $237.6 million, or 35.3% of net sales, compared with $301.5 million last year, or 35.0% of net sales. The decline in gross profit dollars was primarily driven by a 30.4% decrease in sales in the mobility platform. Excluding inventory reserves related to store closures, our consolidated gross profit was $235.6 million, or 35.0% of net sales.
Consolidated selling, general and administrative (SG&A) expenses were $323.6 million, or 48.0% of net sales, compared with $334.4 million last year, or 38.8% of net sales. This represents a 9.2 percentage point increase as a percentage of net sales and operating revenues for the 13 weeks ended August 2, 2014, which was driven by declining sales volumes period over period. Excluding the impact of severance costs related to potential store closures, consolidation of certain facilities in China and a non-cash charge related to the elimination of a key executive life insurance program, our SG&A was $306.3 million dollars, or 45.5% of net sales. These adjusted SG&A dollar decreases were primarily related to compensation and advertising as a result of our cost reduction efforts.
Operating loss for the second quarter was $119.4 million compared to operating loss of $51.1 million last year. On an adjusted basis, operating loss was $83.5 million excluding certain non-cash items and $8.6 million in severance and $20.6 million in impairments of fixed assets and goodwill, partially offset by $2.0 million in reserves in inventory.
Loss from continuing operations was $137.4 million, or $1.35 per diluted share, compared to a loss from continuing operations of $51.4 million last year. On an adjusted basis, loss from continuing operations was $101.5 million, which compares to an adjusted loss from continuing operations of $62.9 million last year.

26 WEEKS ENDED AUGUST 2, 2014, SUMMARY
Total net sales and operating revenues were $1,410.5 million, compared to $1,709.8 million last year. Comparable store sales were down 16.9% driven by traffic declines and soft performance in the mobility business.
Consolidated gross profit was $506.3 million, or 35.9% of net sales, compared with $642.4 million last year, or 37.6% of net sales. The decline in gross profit dollars was primarily driven by a 24.7% decrease in sales in the mobility platform. Excluding inventory reserves related to store closures, our consolidated gross profit was $500.2 million, or 35.5% of net sales.
Consolidated selling, general and administrative (SG&A) expenses were $659.5 million, or 46.8% of net sales, compared with $668.1 million last year, or 39.1% of net sales. This represents a 7.7 percentage point increase as a percentage of net sales and operating revenues for the 26 weeks ended August 2, 2014, which was driven by declining sales volumes period over period. SG&A expenses for the six months ended July 31, 2013, included a gain on the sale of a building of $2.4 million. Excluding the impact of severance costs, consolidation of certain facilities in China and a non-cash charge related to the elimination of a key executive life insurance program, our SG&A was $642.2 million dollars, or 45.5% of net sales. These adjusted SG&A dollar decreases were primarily related to compensation and advertising as a result of our cost reduction efforts.
Operating loss through the second quarter was $200.4 million compared to operating loss of $61.4 million last year. On an adjusted basis, operating loss was $165.5 million excluding certain non-cash items and $8.6 million in severance and $21.4 million in impairments of fixed assets and goodwill, partially offset by $6.1 million in inventory reserves.
Loss from continuing operations was $235.7 million, or $2.31 per diluted share, compared to a loss from continuing operations of $74.7 million last year. On an adjusted basis, loss from continuing operations was $200.8 million, which compares to an adjusted loss from continuing operations of $89.4 million last year.

LIQUIDITY
The Company ended the quarter with total liquidity of $182.5 million at August 2, 2014, including $30.5 million in cash and cash equivalents and $152.0 million of availability under the 2018 Credit Agreement. This availability is net of letters of credit totaling $89.4 million and $43.0 million in borrowings outstanding at August 2, 2014. The Company's total debt was $658.0 million at August 2, 2014, which matures between 2018 and 2019.

This is just a huge burn rate. And these operating income numbers don't reflect the $16.9 million in quarterly interest expense, which is almost $70 million annualized.

The comp store sales decline was worse this quarter than the first half of the year, meaning that the trend got worse. Apparently that was because cell phone sales deteriorated even more during this quarter, going from a 25% yoy decrease to a 30% yoy decrease.

Radio Shack CEO Comments On Q2 $RSH

From press release:

"As for the second quarter, our retail business, which represents approximately half our sales, saw an improving sales trend. That trend is continuing into our third quarter as our turnaround strategy gains traction on the retail front. We are working to lessen our dependence upon the mobility business as we continue to reinvigorate our store experience and revamp our product assortment. We're seeing strong consumer response to new offerings such as our Fix It Here program, where we can quickly fix mobile phones right in our stores, and we are also beginning to see the effect of our pipeline of innovative and differentiated products.

"At the same time, we have been challenged by the persistent industry-wide decline in consumer electronics and soft mobility market," Mr. Magnacca continued. "The postpaid mobility business drove the majority of the weak performance this quarter due to lackluster consumer interest in the current handset assortment, consumers waiting for an iconic handset launch this fall, and intense promotional activities by the wireless carriers. We are working to address our challenges head-on and focus on profitable sales by improving the technology we use to sell mobile phones and bringing in new wireless offerings. We believe that, long-term, our adjusted approach to mobility will position it as an important contributor to our overall business."

Bankruptcy Warning in Radio Shack 10-Q $RSH

This morning's 10-Q:

We have experienced losses for the past two years that continued to accelerate into the second quarter of fiscal 2015, primarily attributed to a prolonged downturn in our business. Our ability to generate cash from operations depends in large part on the level of demand for our products and services. We continue to face an uncertain business environment and face a number of fundamental challenges in our mobility business due to consumer interest in handsets available in the market today, aggressive price competition on these products andintense wireless carrier marketing activities. Our retail business also faces the challenge of revamping our product assortment to anticipate and meet our customers’ needs and wants to produce profitable operating margins. We believe these challenging market conditions will continue for the third quarter and possibly the balance of the year.

Given our negative cash flows from operations and in order to meet our expected cash needs for the next twelve months and over the longer term, we will be required to obtain additional liquidity sources, consolidate our store base and possibly restructure our debt and other obligations. We are exploring alternatives and are engaged in discussions with third parties as well as our key financial stakeholders, including our existing lenders, bondholders, shareholders and landlords, in an effort to create a long-term solution. Alternatives include the sale of the company, partnership through a recapitalization and investment agreement, as well as both in and out-of-court restructuring. We presently anticipate announcing a recapitalization alternative, in the near term, which may be our most likely course of action, but we are continuing to evaluate all of our alternatives to restructure existing debt terms and other arrangements to provide additional liquidity. There can be no assurance that we will be able to successfully implement a long-term solution.

If acceptable terms of a sale or partnership or out-of court restructuring cannot be accomplished, we may not have enough cash and working capital to fund our operations beyond the very near term, which raises substantial doubt about our ability to continue as a going concern. As a result, we may be required to seek to implement an in-court proceeding under Chapter 11 of the United States Bankruptcy Code (“Bankruptcy Code”). If we commence a voluntary Chapter 11 bankruptcy case, we will attempt to arrange a “pre-packaged” or “pre-arranged” bankruptcy filing. In a “pre-packaged bankruptcy”, we would make arrangements with new and existing creditors for additional liquidity facilities and the restructuring of our existing debt terms, before presenting these arrangements to the bankruptcy court for approval. In the absence of a “pre-packaged” bankruptcy, we would consider a “pre-arranged” bankruptcy filing, in which we would reach agreement on the material terms of a plan of reorganization with key creditors prior to the commencement of the bankruptcy case. An in-court restructuring proceeding would cause a default on our debt with our current lenders.

We anticipate that in the near term we will seek to pursue one of the alternatives described above which may include a restructuring of existing debt terms and other arrangements to provide additional liquidity. As part of the various alternatives, we may begin a program to close a number of underperforming stores and other measures to make reductions in our cost structure. However, the actual number of store closures could vary considerably depending on the specific restructuring alternative implemented. Absent an agreed upon restructuring plan, the store closure program would require consent from our lenders.

There can be no assurance that any of these efforts will be successful. Each of the foregoing alternatives may have materially adverse effects on our business and on the market price of our securities. In the event the restructuring alternatives described above are not achievable, we would likely be required to liquidate under Chapter 7 of the Bankruptcy Code.

I was surprised that they weren't able to announce some sort of recapitalization package with earnings.

I've never seen a company expound on the difference between "pre-packaged" and "pre-arranged" bankruptcy like that either.

Good Reader Comment on the Einhorn Book Review

Good reader comment on my review of Fooling Some of the People All of the Time, A Long Short Story by David Einhorn:

"I found FSOTPAOTT fascinating. Not so much for its description of Allied, which was a run-of-the-mill BDC Ponzi, but for Einhorn's rationale for sticking with a losing investment for years. He writes at the beginning of the book about the dangers of having an 'evolving thesis' and then does exactly that with Allied.

I suspect he would have been quicker to cut his losses if he hadn't criticized the company publicly. When they responded to his presentation by blatantly lying, that set him off and made him obsessed with proving the company was a fraud. He says it's a cautionary tale about nefarious companies, lazy regulators, etc.--- I would say it's a cautionary tale about marrying your trades and feeling a need to be right.

Allied doesn't seem to have performed worse during the credit crisis than other BDCs like ACAS. I looked up historical data for Sirrom, and it likewise doesn't seem to have done worse than other BDCs in 1998-- they were all down 50%+ during the LTCM drama."

That's a great point about the evolving thesis. And the public bashing is dangerous. Look at Ackman and Herbalife. (I think Hempton is right and Ackman is wrong, btw.) A gigantic, public position becomes something from which you can't back down.

Another Thought About Amazon and The Everything Store

Followup thought on my review of The Everything Store: Amazon's market capitalization is more than half the value of WalMart already. And it's not like Amazon is likely going to be worth over a trillion dollars - you probably can't make 10x on it. And you could lose 100% if something bad happens to discretionary spending or shipping costs. And no cash flows in the interim!

Review of The Everything Store: Jeff Bezos and the Age of Amazon by Brad Stone

I never know what to make of Amazon. I buy more and more there every year. It used to just be new books, but now I buy my used books there instead of Half.com (too eBay-ish). Also buy any mp3s, certain office supplies, electronics (sorry Radio Shack), power tools, basically most things that are SKU'd and branded. I would never buy anything unbranded on there because that type of stuff always turns out to cheap junk from China.

Of course, anyone looking at Amazon stock wonders about the $150 billion enterprise valuation versus the $4 billion in EBITDA. Revenue and gross profit (27% gross margin) grow at a fast clip but EBIT does not.

Bezos is also just a fascinating fellow. I've written about the 10,000 Year Clock before. Before reading The Everything Store biography and corporate history, I did not know he had invested in Google. (And I forgot that Amazon was established well before Google.) I wonder how much money the very early Google investment turned into? It also says that he invested in Twitter and Uber.

Certainly the story of Amazon is fascinating. However, It's amazing that people are writing business books that have no charts, no financial statements, no valuation ratios. Journalists really are not good at reporting the type of details that would help you understand a business, and the decisions that management and investors made over time.

Journalists prefer sensational, emotional stories that follow an arc. Bezos' wife was annoyed with The Everything Store and gave it 1 star in her Amazon review! At least with the Vanderbilt or Carnegie biographies, there's the excuse that the detailed financial data would be so hard to come by.

Instead, read last week's Amazon essay, Why Amazon Has No Profits (And Why It Works). As he puts it,

"On one hand, there is the ruthless, relentless, ferociously efficient company that’s building the Sears Roebuck of the 21st Century. But on the other, there is the fact that almost 20 years after it was launched, it has yet to report a meaningful profit."

His take is that Amazon, at the highest level of abstraction, is a venture capital fund.

Amazon wholly owns a number of portfolio businesses which are at different stages of maturity. Certain businesses (books?) are well established and profitable. Others are "startups" that are unprofitable because they are new or because they are using Bezos favorite loss-leader strategy.

Evans thinks that the money is going into more fulfillment capacity and to expanding Amazon Web Services, the "cloud" on which an amazing number of internet companies are run. He says, "when you buy Amazon stock (the main currency with which Amazon employees are paid, incidentally), you are buying a bet that he can convert a huge portion of all commerce to flow through the Amazon machine."

The most important Bezos concept is the flywheel, and it's worth having in your mental toolkit.

With regard to Amazon, I think the bullish thesis - they are unprofitable because of growth investments - is probably right. The problem is, there's a way for that thesis to be right and for bulls to still lose. What happens if the future of discretionary purchasing - and that's all Amazon is for - isn't that bright? What if American consumers find a lower level of confidence that better fits their reduced future circumstances, and they tighten their belts?

Then the flywheel would essentially run backwards; the huge fixed costs of the capex investments working against you.

3/5

Review of Fooling Some of the People All of the Time, A Long Short Story by David Einhorn

Allied Capital was a "business development company" - sort of like a bank except funded more with equity - that made "mezzanine" (that is, high loan to value) loans to corporations. It was mostly owned by retail investors who were hungry for the high dividend yield and couldn't really analyze the company much beyond that.

Poor David Einhorn shorted Allied Capital in 2002 and spent years talking it down and trying to get regulators to investigate its admittedly suspicious sounding accounting for loan impairments.

However, at the same time that Einhorn was shorting Allied, he had a significant long position in New Century Financial. Here was the rationale that he gave in a speech [pdf] at the Value Investing Congress on November 10, 2006:

"We have a company in our portfolio, New Century Financial (NEW), that turned a wonderful non-capital intensive business, the origination and sale of mortgages, and reinvested the cash flows into a mediocre capital intensive business of holding mortgage loans. Worse, they went into the capital markets to raise additional capital to focus on the capital intensive opportunity. I thought this was such a bad idea that I joined the Board with the goal of unwinding this decision and to free the valuable service business from the investment business. It is too soon to discuss my progress."

He was right that the company made a mistake by expanding into the business of owning/holding mortgage loans. However, it is also clear from his comment (and the fact that he owned a big stake in the company) that he completely missed what was going on in the mortgage market; both in the New Century portfolio and in the entire U.S. market. He did not resign from the board until March 2007.

Allied Capital did poorly in the financial crisis, but it lasted until 2010 when it was taken under at $5 per share. Much better performance than New Century which of course went to zero. This old Bloomberg article says that Einhorn's fund lost $140 million on New Century.

Note that the book came out in May 2008, which means he had probably been working on it in 2006 and 2007. Working on a book is very time consuming. It's also backward looking, which is why there are not very many great investment books. What if he had done real estate field research instead of working on this book? Greenlight lost 20 percent in 2008 [annual letter PDF]. 

I haven't read the new version of Fooling Some of the People All of the Time, A Long Short (and Now Complete) Story, Updated with New Epilogue, but the conclusion I draw from the original version is that life is too short to chase after the fraudulent stock shorts. Actually, the more crooked management, the harder it is to make money. Frauds can go on for years and years and years. As long as a fraud can attract investors fooled by some kind of batesian mimicry - in this case a high dividend yield - it can persist.

But if a company is unprofitable and it owes more money than it can repay, the creditors can be the catalyst for the short.

3/5