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Google, Microsoft and News Corp. Fight while Consumers Remain Anchored on Free Content

2009-11-26T16:58:00.003-05:00

Published by clickbroker.blogspot.com.

Google (GOOG) fights for net neutrality and the right to index all of the world’s information for free. Verizon (VZ), AT&T (T) and content providers are out to slay the Google dragon. Microsoft’s (MSFT) Bing search engine fights to grab market share from Google. And News Corp (NWS, NWSA) is conspiring with Microsoft to take Google down a few notches.

The Associated Press (a cooperative) and its member publishers claim that original reporting is the root of the internet, from which all opinion is derived. Without original content there would be no internet. News Corp mogul Rupert Murdoch takes this further by saying advertising cannot support original content and rampant exploitation of original content by secondary sites such as search engines goes beyond the doctrine of fair use.

Murdoch’s insistence that profits derived from his content must flow back to News Corp is likely to be focused on big pocket sites like search engines. Tracing Murdoch’s roots to the end of the internet would obviously produce diminishing returns. Murdoch feels emboldened by The Wall Street Journal’s ability to charge for online subscriptions, a feat few other publications can claim. Even Murdoch is treading carefully with his other publications. But as the printed newspaper becomes obsolete, a new business model must emerge.

“Pay to play” has had many twists and turns in the business community – some legal but most conjure shady behavior or antitrust concerns. Consumer staples manufacturers like Procter & Gamble (PG) and Campbell Soup (CPB) have to pay supermarkets like Safeway (SWY), Wal-Mart (WMT) and Target (TGT) for shelf space. Intel (INTC) got in trouble for previously paying rebates to keep AMD (AMD) out of Dell (DELL) and HP (HPQ). And now it is widely reported that Murdoch is negotiating to give Microsoft’s Bing search engine the exclusive right to index News Corp’s content for cash.

Google allows content providers to opt-out of indexing, but I am concerned about payments and exclusivity arrangements. From a public policy perspective, incomplete search results are not a benefit to either researchers or content providers. I do agree, however, that search engines should pay to display copyright text excerpts, images and videos beyond fair use. AP cites uncontrolled fair use abuses.

With consumers anchored on free content, advertising not footing the bill and pay to play on shaky grounds, what is the path forward? I believe the model should focus on subscriptions as a reward for other consumer purchases or behaviors. Customers are anchored on water being free at restaurants and would be insulted if they had to pay for it. But no water would be provided if no food was ordered.

Content providers should pick up where the airlines rewards programs are collapsing under their own weight. At 50,000+ miles for a domestic flight, these rewards are becoming virtually meaningless. But if credit cards offered online subscriptions to The New York Times (NYT), which is currently free to consumers, or The Wall Street Journal, consumers have tangible rewards. And their incremental cost to publishers would be minimal; virtually total profit for the sale of rewards. Inventory is not an issue in the online world.

When the consumer is anchored in free, the much touted micro-payment model has little chance of success. The big packaged food companies as well as “organic grocer” Whole Foods (WFMI) know they have to package each new food fad into a taste consumers will tolerate. True whole-grain is too distasteful, so consumers will only go as far as processed whole-grain. Give consumers what they want and both consumers and business will feel good about themselves. Consumers will not feel good about making payments – micro or otherwise – for content they feel they are entitled to for free.

Content originators must be content with consumers paying indirectly for their work. Trying to change a consumer behavior as strong as free internet content is futile. But purchasing $3,000 a year on VISA (V) or MasterCard (MA) to earn an online newspaper subscription follows established behavior. So Rupert, go forth and sell rewards. Macy’s (M) or even Starbucks (SBUX) might be just waiting to offer them to their best customers.

I see Murdoch initiating the next Green Stamps revolution. As an added benefit, both the publishers and the retailers would have endless data mining fun!

No Disclosures.

Is America Ready for Assembly Line Medicine?

2009-11-24T11:27:00.011-05:00

Published by clickbroker.blogspot.com.

While Cigna (CI), Humana (HUM), UnitedHealth Group (UNH) and WellPoint (WLP) are too timid to ask, The Wall Street Journal’s “The Henry Ford of Heart Surgery”, subtitled “In India, a Factory Model for Hospitals Is Cutting Costs and Yielding Profits” reports that foreign entrepreneurs have found success. The American model of one or more generalist hospitals in every two-bit town has given way to extremely large regional specialty hospitals in India.

The question becomes what, if anything are Americans willing to give up for improved quality and lower costs? We currently have a model of regional trauma centers for real emergency care, with a fleet of medevac helicopters on standby for car accidents and earthquakes. But we are so far unwilling to travel for non-time sensitive heart or cancer operations. (Operations that can wait from one week to a month or more.)

Despite all the rhetoric about the strain on the current stock of doctors and medical facilities that expanding health insurance will exert, our current facilities are severely underutilized. Why else would doctors, hospitals and pharmaceutical companies be relentlessly advertising? If Medicare was so severely underpaying doctors and hospitals, why are they fighting for senior patients?

The answer is that they need to fill their offices and beds. As Willie Sutton said when asked why he robbed banks “"because that's where the money is.” Seniors and Medicare is where the money is – virtually all the money.

Dr. Devi Shetty runs the 1,000-bed Narayana Hrudayalaya Hospital in India that performed 3,174 cardiac bypass surgeries in 2008. Unlike the US, the 42 staff cardiac surgeons perform two to three operations per day, six days a week. The surgeons earn $110K to $240K per year depending on experience, and the hospital has complete diagnostic services in-house. Skills increase with concentration in these types of specialty hospitals.

Dr. Jack Lewis, chief executive of the American College of Cardiology confirmed Dr. Shetty’s model. High volume increases quality. Dr. Shetty cites the Japanese manufacturing model of continuous improvement. "In health care you can't do one big thing and reduce the price," Dr. Shetty says. "We have to do 1,000 small things."

The average $2,000 price Dr. Shetty charges for an operation might not be replicable here when Americans are charged anywhere from $20K to $100K. But there is no reason why the free market shouldn’t push toward more regionalization and specialization of medical services.

Not even the staunchest conservative would argue that America actually has a free market in healthcare. We have a hybrid market where inefficient providers are protected and consumers are reluctant to be shifted from doctor to doctor as they work their way down the medical assembly line. Doctors too are reluctant to give up patient dollars to more efficient operators. Insurers are also guarded in paying to transport patients to the most efficient and highest quality facilities.

Just as it is far cheaper to conserve energy than build more power plants, it is far cheaper to shutdown inefficient local hospitals and expand regional facilities. With the expansion of computerized medical records, I see little benefit to a patient having a personal doctor, much less a personal surgeon. Have there been any clinical studies showing the benefits of long-term doctor patient relationships?

The last issue might be the value of having family and friends close by, able to visit hospital patients often. Spouses might have to work while patients are hospital bound. Insurers could find that it is cost effective to pay travel and lodging expenses for family. Alternatively, clinical trials might find that family visitations have no affect on outcomes. There is always the telephone.

No disclosures.

Fed: Bubble Surgery must wait for Perfect Information

2009-11-16T20:56:00.006-05:00

Published by clickbroker.blogspot.com.

Bloomberg’s "Bernanke Says ‘Not Obvious’ Asset Prices Misaligned" and The New York Times’ "Bernanke Worries About Weak Dollar" report that a very Greenspan-like Bernanke spoke before the Economic Club of New York Monday. After acting recklessly over the past year to save the world from depression two, Bernanke is too timid to act against the current stock market, Treasury and gold bubbles without perfect information.

At least Greenspan was clear in his objective – innovation creates bubbles and bubbles create innovation. So therefore benefit from innovative bubbles and cleanup afterwards.

Greenspan’s protégé (Bernanke) has difficulty being as succinct. High unemployment takes precedence of potential inflation. While there is no need to worry about the crashing dollar, if that creates inflation interest would have to rise. But for the persistent slack in utilization, there is no need to raise interest rates for “an extended period.” Is any of this perfect information?

Truth is that both Greenspan and Bernanke recognized bubbles during their creation. Just like Bernanke, Greenspan refused to admit it while Fed chairman. It was not until sometime after leaving office that Greenspan espoused his bubble philosophy. Following suit, Bernanke said that it is “not obvious” that a 64% bounce back in the S&P 500 (SPY ETF) is indicative of an asset bubble. Star banking analyst Meredith Whitney preannounced on Monday that it is obvious to her.

Being obvious has never been an issue for either of these gentlemen. It just that Greenspan lived in an aura of infallibility and Bernanke does not. Perfect knowledge didn’t stand in the way of the policies both wanted to pursue, of which inflation control was never included. Growth was always more important.

Finally, as is many times quoted, “words have meaning.” Price stability is not the same as zero or limited inflation. These Fed chairman read price stability to mean preventing deflation at any cost and revving up the economy to its maximum potential.

Inflation and assets bubbles are just a few zits on our perfect complexion. So put on some Bernanke branded face cream and let’s go to dinner.

Limits of a Knowledge-based Economy

2009-11-13T12:14:00.003-05:00

Published by clickbroker.blogspot.com.

The Wall Street Journal’s “Tinkering Makes Comeback Amid Crisis” stirred my thoughts on the limits of America’s dependence on a knowledge-based economy. The article focused on engineering students at prestige universities wanting to actually create physical things. Students are migrating from the virtual world of software science to hobby-ing with computer controlled milling machines in their dorm rooms, school workshops and membership machine shop clubs.

The Journal’s “Obama to Warn Asia Against Relying on U.S. Consumers” reports that the President is reiterating his call for the US to get back to making things for itself and the rest of the world. In “Larry Summers and Jeff Immelt Preparing for Post-Consumer Economy” and "US Needs to Convert from a Consumer to an Industrial Economy", I highlighted that companies such as Eaton (ETN), Ingersoll-Rand (IR), Parker Hannifin (PH) and Rockwell Automation (ROK) could be the beneficiaries. Now it appears that both the President and these companies are developing a young following.

While the President will be emphasizing balance during his Asian trip, the underlying message to the world is that the US consumer is finished, spent out, and will never return. The President doesn’t want foreigners to lend us any more of our own money to buy any more of their trinkets. The inherent conflict between the Administration and the Federal Reserve is the sustainability of our economy based on recycled dollars. Obama would rather recycle the Pound, Euro, Yuan and Yen in our favor. Bernanke still believes that the US consumer will save the world.

The previous conventional wisdom was that it is too expensive to make anything in the US, so we must concentrate on the high value-adding knowledge-based economy to be competitive. That proved a failure as each time the Fed pumped up the “economy”, i.e. money supply, it only created asset bubbles – not more industrial capacity or real innovation. True innovation and the real knowledge-based industries evolve in fits and starts; therefore they will never be enough to drive an economy as large as the US.

Now it’s time to take a step out of fantasyland. The US needs a “core” economy that supports all skill levels, personal spending that matches personal income, and an energy policy that matches consumption with its percentage of the world population and its accesses to resources.

Whether the Fed likes it or not, the central bank can no longer play US consumers like a violin. We are already diverting too large a portion of our consumption to energy. So that leaves the availability of work for all skill levels as the central focus.

It is time to end all the rhetoric about the need for better education and fair trade for the US to compete in the world. Both are overused excuses in the same manner as pharmaceutical companies say they must gouge consumers to support research. While the quality of our education varies substantially, the high-end is still extremely competitive. Education and skills are not stubbing our economy. And trade will become fairer as our consumers adjust spending to match their incomes.

So what will force the economy to reindustrialize? I believe it will come when many of the knowledge-based commerce businesses such as banking, finance and accounting become utilities. Yes, the Bank of America (BAC) Electric Co., the Citigroup (C) Electric Co., the JP Morgan (JPM) Electric Co., the Wells Fargo (WFC) Electric Co., and even the Faux Goldman Sachs (GS) Virtual “We are not a retail bank” Electric Co. As services lose their ability to value-add, industrials will pick up the slack and jobs will fill in at all skill levels.

I am not advocating the doom of the knowledge-based technology sector, just a substantial decline in the knowledge-based services sector because of the realization that most services have never been value adding. And non-value adding services could never have been the foundation of a sustainable economy.

I am betting that President Obama’s vision of the US and world economies will be right by default.

Disclosures: Author is long BAC, C and WFC.

Isis, Ligand and Vical: Core Biotech Holdings

2009-11-09T11:24:00.006-05:00

Published by clickbroker.blogspot.com.

Isis (ISIS), Ligand (LGND) and Vical (VICL) have been my core biotech holdings since the mid 1990s and I have been steadily adding to these positions each time the market has lost faith. They share common themes and some differences. Isis and Vical have maintained consistent management throughout the years, whereas Ligand radically changed direction a few years ago when Daniel Loeb’s Third Point hedge fund took a stake. Now all three are focused on drug discovery; leaving the marketing to others.

All three have many pharmaceutical partnerships and many shots on goal, so one failure would not be devastating. In order of platform strength and a protective moat around their technology; Isis is the strongest, followed by Vical, with Ligand pulling up the rear.

Ligand has announced a strategy of picking up funded drug candidates through low cost mergers with desperate cash-strapped micro-cap biotechs. They want to partner their internal development candidates at the earliest possible inflection point, but not much past the initial phase 2 “proof of concept” clinical trials.

Historically, Ligand sold over half of its potential royal streams and settled for higher upfronts over royalties to build a commercial sales organization for a few fledging products. Third Point installed new management, sold Ligand’s commercial products, declared a special $2.50 dividend and set the company on the path of operating cash flow neutral.

Three potential blockbusters are close to launch by GlaxoSmithKline (GSK) and Pfizer (PFE) with sacrificed royalties. Now Ligand is showing more emphasis on royalties than the upfront, a better balance. The encouragement is that new deals are being negotiated with mid-teen and higher royalties. Looking back, I had too much faith in Ligand’s old management and now I’m solidly on Dan Loeb’s team with Ligand.

Isis’ years of failure have been legendary, but the Genzyme (GENZ) almost $2B deal on the Mipomersen cholesterol drug was the turning point. Together with the $200M sale of Ibis Biosciences to Abbott (ABT), Isis has almost as much cash as India has gold. Isis has over 20 drugs in development and repeatedly committed to keeping its employment below 325 while continuing to rev its discovery engine in high gear.

Both Ligand and Isis will be high earners when royalties start flowing and expenses are maintained at a low level. The difference is Isis is willing to take the clinical process to a higher inflection point to get 50% profit sharing whereas Ligand will settle for less risk and investment to get a 15% royalty. But, neither company wants a sales force.

Vical has been more ambiguous about commercialization. Their DNA vaccine platform has some pharmaceutical and government sponsorship, and they are retaining US rights to their cancer vaccine. Vical is the most risky of the three companies with only about 2 years of cash and limited research funding. But, they have some drugs in phase 3. The bet on Vical is that DNA based vaccines are the only way to respond quickly to potential pandemics.

My core biotech holdings are high risk, high reward. What they have in common is no fear of future product discovery. They can partner knowing there are always more drugs to come. I try to avoid all or nothing biotechs.

Don’t be fooled by one product cancer companies alleging that they will diversify into other indications for their one drug. Most of the time, other indications fail. Know that a single drug is not a platform. My core biotechs are all platform companies; Isis and Vical are based on solid technical platforms and Ligand is based a solid business platform.

PS: PDL Biopharma (PDLI) learned it was a mistake to resist Daniel Loeb’s advances.

Disclosure: Author is long Isis, Ligand, PDLI, PFE and Vical.

Currency, Foreign Stocks and Dividends

2009-11-05T19:48:00.001-05:00

Published by clickbroker.blogspot.com.

The popularity of foreign stocks ebbs and flows, but there’s always someone on TV touting them for either growth or diversity. I have owned a few large-cap foreign stock ADRs (American Depository Receipts) from time to time, but none presently. I would like to relate some of the nuances that I experienced. I never owned any foreign stock ETFs or mutual funds, but the discussion can easily be applied to them as well.

ADRs are issued by depository banks and trade on US exchanges in US dollars. The depository banks distribute the dividends from foreign stocks into US dollars, extracting a fee from the shareholders annually when not reimbursed by the foreign company. The fee shows up as debit on your brokerage statement at the same time the dividend is posted. Additionally, you will see a debit for foreign taxes related to the dividend, even if the ADR resides in a tax-free (Roth IRA) or tax-deferred (Traditional IRA) retirement account. Luckily the fees and taxes have never been greater than the dividends for me.

ADRs represent either a multiple or fraction of the ordinary (common) shares of foreign companies. Arbitragers keep the price of the ADRs in line with the ordinary shares and the currency exchanges rates. This gets far more complex with foreign ETFs which often trade at large premiums or discounts to net asset values.

Let’s look at how currency affects ADR pricing and dividend yields. For simplicity I am assuming that the foreign companies are growing at similar rates to the US companies and stock price appreciation is on par. A stronger dollar would price an ADR lower relative to the ordinary shares, given that one dollar buys more foreign currency. A weaker dollar would conversely raise the price of the ADR relative to the ordinary shares.

When the dollar is weak and you predict it is getting weaker, you’ll start out overpaying for ADRs, but they could continue to increase in price. If the dollar strengthens and the ordinary shares don’t increase enough in value, you could lose money.

ADR dividends behave similar to ADR price, but dividends don’t have the advantage of increased expectation of ordinary share prices. When the dollar weakens, ADR dividends increase due to dollar translation. Conversely, when the dollar strengthens, ADR dividends decrease. Absolute yield will then depend on the price behavior of the ordinary shares.

Foreign large-cap stocks typically pay dividends only once or twice a year, and the dividends are high relative to US stocks. This makes yields deceiving if the prior dividends are not adjusted for currency in real-time. Also, most foreign dividends are not fixed as the US. Foreign dividends are often based on a percentage of profits and companies must actually make a statutory profit in order to be allowed to pay dividends.

As a general rule it is better to buy foreign stocks and ETFs when the dollar is strong, unless you are a closet currency trader or are especially knowledgeable in foreign companies and economies.

GlaxoSmithKline (GSK) and Taiwan Semiconductor (TSM) are examples of ADRs.

Wells Fargo Tries “Family Values” on Legacy Wachovia Pick-A-Pay Mortgages

2009-11-05T13:05:00.000-05:00

Published by clickbroker.blogspot.com.

The Wall Street Journal’s “Wells Fargo Takes Chance With a Loan Exchange”, subtitled “Option ARMs Are Shifted to Interest-Only in a Recovery Bet” suggests that the bank is playing “kick-the-can down the road” with its Pick-A-Pay mortgages. Wells Fargo (WFC) is holding $107B in legacy Wachovia ARMs that have accumulated both negative amortization and substantial housing price drops, leaving the homeowners in unrecoverable positions. The bank is hoping that time will heal the wounds.

Homeowners that either chose or could only afford payments that did not even cover interest were allowed to accumulate negative amortization usually up to between 110% and 125% of the original loan amount. After reaching the negative amortization cap, the homeowners then have to both start paying the full interest and start amortizing the principal over the remaining life of the loans. In most cases the loans become unaffordable.

Wells Fargo is offering certain Pick-A-Pay customers a reduced fixed interest-only adjustment for 6 to 10 years, along with limited principal reductions. The bank believes that the economy and housing prices will recover enough for these loans to again be profitable, or at least provide a higher net present value than foreclosure.

In essence, Wells Fargo is turning the Pick-A-Pay borrowers into renters. These homeowners will never recover their equity. But the bank argues that the homeowners selected to benefit intensely want to keep their children in a stable home and school environment.

Will the “family values” argument overpower the economic argument for homeowners to flee an underwater property? I cannot say, but these homeowners certainly don’t have any incentive to spend on maintaining their properties. The bigger question is what collateral will the bank be left with when the homeowner chooses to patch rather than replace the roof?

Disclosure: Author is long WFC.

Bank of America, Citigroup, JP Morgan and Wells Fargo Stocking Up on Liquidity

2009-11-02T18:03:00.005-05:00

Published by clickbroker.blogspot.com.

Geithner’s Treasury and Congressional politicians are telling banks publicly to expand lending and boost the economy. At the same time Bernanke’s Federal Reserve is telling banks to increase liquidity as the banks see little loan demand from qualified borrowers.

Adequate capital and adequate liquidity are two completely separate concepts as Bear Stearns and Lehman found out the hard way. Capital is purely an accounting concept, generally consisting of common and certain preferred equity. Liquidity on the other hand is the cash either available or that can be generated to meet funding obligations in the event of deposit withdraws or a freeze in short-term credit.

Bloomberg’s “Bank of America Joins China as Buyer of Treasuries” and “Pandit ‘Near Death’ Cash Hoard Signals Lower U.S. Bank Profits” explore how bank fears and regulatory pressures are moving banks counter to the economic recovery. Liquidity is generally defined as cash, deposits at other banks and any debt securities that the Fed will accept as collateral for overnight loans. Citigroup (C) only earns 0.63% on liquid assets vs. 7.2% it could earn on loans.

Bank of America (BAC) September liquidity stood at $422.6B, 19% of assets; Citigroup $450.3B, 24% of assets; JP Morgan (JPM) $453.6B, 22% of assets and Wells Fargo (WFC) $201B, 16% of assets. In cash alone, JP Morgan is holding $80.7B and Citigroup an amazing $245B. The big four banks are claiming that they are protecting themselves from adverse conditions. None of the banks reported regulatory pressure.

Wells Fargo claims that it has less need for liquidity than its other top rivals. In the ratio of deposits, long-term debt and equity to assets; Wells Fargo stands at 92% compared to Bank of America at 75%, Citigroup at 72% and JP Morgan at 63%. From the exposure to short-term funding risks, JP Morgan is showing its investment banking characteristics far more than the others.

Whether JP Morgan is more or less risky than its big four peers might be judged on the quality of its assets. The term risk weighted assets is often thrown around when discussing adequate capitalization of the banks. Each category of asset is weighted from 0% risk for treasuries to a very high weighting for leveraged loans and risky consumer finance. Then the weighted assets are summarized and divided by the various capital definitions.

The level of haircut the Fed takes on collateral is probably similar to risk weighting for regulatory purposes. The trouble is that the risk weighting is credit based and does not take into account interest rate risk. So too liquidity has an interest rate risk in all but the shortest term assets. Therefore, a bank’s liquidity could shrink with a rise in interest rates.

With this heightened emphasis on liquidity, it is interesting that banks are holding only a composite $125B or about 1% of assets in treasuries. Barclays (BCS) says that the norm after recessions is for banks to hold an average 8.5% of assets in treasuries, giving them the capacity to hold up to $1T. Barclays believes that banks will jump in as the Fed has quit quantitative easing (monetizing the debt). This might be a stretch as the interest rate risk in treasuries is especially high and banks have used Fannie Mae (FNM) and Freddie Mac (FRE) debt as higher paying 0% risk weighted alternatives.

Treasuries still have the role as the main currency on Wall Street. So demand will always exist for the short-term near zero rate instruments. Bank of America is holding $31B in treasuries and Citigroup has $17B in treasuries “available for sale.”

Given that investment grade corporate bond yield fell from a post Lehman average 7.96% to an average 5.06%, the Fed has certainly created a bubble. Perhaps this is why our big four banks are willing to forgo earnings to keep such a large percentage of their liquid assets in cash. In essence, returning money to the Fed for nearly free to forgo interest rate risk.

I like the new emphasis on liquidity by the top commercial banks, but caution that it might not provide as much security as it appears. Former Fed Chairman Greenspan is already warning that excess bank liquidity is unsustainable with market expected bank profits, economic growth and that tainted word "innovation."

Bloomberg’s “Private Equity IPOs Slump as Goldman, Citigroup Can’t Sell AEI” is reporting additional difficulties on the investment banking side. Institutional investors are not willing to accept IPOs with less than stellar balance sheets. Goldman Sachs (GS) and Citigroup were unable to float AEI, a former Enron power plant and natural gas pipeline operator, at any price. That is not good for IB fees and a sign of continuing trouble for private equity.

The consumer business is getting tougher; credit card reforms and other consumer protections will soon start taking their toll on profits. The mortgage origination business could also begin to falter when the Fed starts easing its purchases of Fannie and Freddie securities, interest rates climb and the pool of qualified home buyers shrinks.

All told the best that I can say is banks are on the road to lower, steadier earnings. I like my banks becoming utilities; that’s why I am staying clear of the “unbanks” Goldman Sachs and Morgan Stanley (MS).

Disclosures: Author is long BAC, BCS, C and WFC.

Financial Reverse Engineering

2009-10-28T12:19:00.001-04:00

Published by clickbroker.blogspot.com.

What do you have when the smartest guys in the room engineer a financial product so complex that it blows up? Even smarter guys that pick through the ruble and steal the diamonds. Genius creates alchemy and alchemy creates genius.

Bloomberg’s “Citigroup Aims to Stop TPG Fund From Stripping CDO” reports the tables have once again turned on Citigroup (C) under the law of unintended consequences. Citigroup has already written down roughly $118B in CDO losses according to Bloomberg’s calculations. Now TPG Credit, separate but associated with private equity firm TPG, has dived deep into the esoteric trust structures to cherry pick some of the best CDO assets from the invalids.

TPG Credit has offered the preferred equity holders of Tropic CDO V and six other CDOs half of their original purchase for a consent agreement to sell specific bank trust preferreds at 5¢ on the dollar. Pay the CDO equity holders $23.5M for the right to buy $470.8M bank trust preferreds for $23.5M, total of 10¢ on the dollar. The CDO preferred equity holders are the first to take losses, so they are given the privilege of choosing which assets and when to sell.

Enough bank preferreds within the CDO have defaulted so that CDO equity holders have stopped receiving income and will soon be wiped out. At the same time higher tranche CDO note holders have seen the market value of their securities double in value recently. Citigroup claims that if the highest quality bank preferreds are sold, CDO equity holders will unfairly benefit at the expense of the highest level tranches (note holders).

I congratulate TPG Credit. CDOs were created with conflicting interest, giving each layer of capital risks and privileges. A purchaser of any tranche should be aware of the privileges or rights of all others in the capital structure. This is why retail investors should be far removed from any structured financial products.

Disclosure: Author is long C.

Inflation and the Hierarchy of Needs

2009-10-18T20:47:00.004-04:00

Published by clickbroker.blogspot.com.

Not to be outdone by Maslow, inflation has its own hierarchy of needs. Basic needs (physical survival) correlate to food and energy, safety (comfort) correlates to core inflation, and self-actualization correlates to asset inflation. The Federal Reserve admits that it has little influence on food and energy, believes that it can control core inflation, and says that it has no control over asset inflation.

I believe the Fed’s rhetoric is only partially truthful. I agree that the Fed has little control over the demand for survival needs. However, when it comes to core inflation (the safety teddy) General Electric (GE), Intel (INTC) and US Steel (X) have more influence on the overall price structure than the Fed.

The Fed is being outright disingenuous when it comes to asset inflation. This form of self-actualization is at the top of the inflation hierarchy of needs. Asset purchases are the most discretionary and the first place for excess liquidity to flow to. While professing the opposite, the Fed has maintained an active policy of promoting asset inflation.

After leaving office, former Fed Chairman Greenspan admitted that the Fed engineered asset bubbles to promote innovation. Even though the housing bust has proved much more difficult than Greenspan had imagined, Fed Chairman Bernanke has not changed policy. Every one of Bernanke’s “specialized” programs has failed to generate targeted core inflation because the Fed cannot really control the application of liquidity, only the intensity of the flow.

The Fed cannot even control which asset sectors get inflated. While the effort to inflate housing prices is failing, stock and even junk bond prices are rising. The question is does the Fed care about targeting asset sectors or just creating a general wealth effect? I believe the Fed’s focus is primarily on managing the overall wealth effect, not inflation in general and least of all the value of the dollar in foreign exchange.

Now we know that both Greenspan and Bernanke have reached self-actualization in the world of asset bubbles. Greenspan’s recent interview with Bloomberg’s Al Hunt was quite telling. He thought the banks could not make a profit and lend efficiently if they were required to maintain capital for long tail events. The role of government is to bailout black swans. Again, the Fed’s policy is to remove any obstacles to asset inflation.

Imprudent lending is Fed policy and that is why Bernanke is so opposed to the creation of an independent consumer protection agency. Protecting consumers from aggressive banking directly stands in the way of promoting the wealth effect. Both Greenspan and Bernanke aspire to see masses of self-actualized consumers.

Regardless of what you think of how inflation is calculated with “owner equivalent rent” and “hedonic” (constant value) adjustments, leaving asset inflation out of the calculation makes the inflation numbers meaningless. Don’t let the Fed tell us that we have no inflation when stocks are up 50% and the dollar is collapsing.

Finally, I am waiting for the Fed to explain in behavioral terms how businesses and consumers changed with each decrease in the fed funds rate. Was the change from 1% to 0% as effective as the change from 5% to 4%?

Wall Street Weather’s "Asset Inflation: The Missing Indicator In Economic And Monetary Policy" provides an excellent discussion of asset inflation and monetary policy.

Disclosures: Author is long GE and INTC.

Lessons of Medicare dis-Advantage

2009-10-16T20:16:00.001-04:00

Published by clickbroker.blogspot.com.

The Washington Post’s “Hidden Costs of Medicare Advantage” reports seniors should beware; Medicare Advantage not only costs the government more but might cost seniors more too. The challenge to healthcare reformers is whether to consider Medicare Advantage an entitlement or an extra cost option for seniors. The opponents of reform are curiously framing Medicare Advantage as an entitlement, while professing opposition to the expansion of entitlement spending.

Let’s examine the pragmatist opponents of reform arguments: 1. Medicare Advantage provides choice, 2. Medicare Advantage improves the quality of care, 3. Medicare Advantage lowers costs for low-income seniors, and 4. raising Medicare Advantage premiums through lower subsidies effectively removes an existing benefit. The opponents don’t discuss the danger seniors face in restrictive provider networks.

Medicare Advantage limits choice of doctors, hospitals and covered procedures. If virtually all doctors and hospitals accept basic Medicare, by definition each network can only be a subset. Whether the advice provided by primary care doctors in Medicare Advantage HMOs improves the quality of care is questionable. But the requirement for a separate referral for every single specialist, test and procedure is enough to weed out the more frail seniors from Medicare Advantage. How easy is it to get a referral if you can’t drive?

During younger seniors’ healthy periods, Medicare Advantage might substantially lower seniors’ medical expenditures. Providing the plans have no additional premiums and minimum “out of pocket” deductibles and co-pays, poorer seniors benefit. But like all private insurance, there of traps everywhere. There could be many situations when a senior actually pays more for the same test or procedure under Medicare Advantage than basic Medicare.

Seniors were never entitled to Medicare Advantage which costs the government an average of $850 per month, 14% more than traditional Medicare. With 25% of seniors on Medicare Advantage, it’s become too politically difficult to take it away. Once a senior starts having a serious or chronic medical problem, the government actually raises its payments to the private insurers. The risk exposure for private insurers is minimized; all upside with little downside.

The only protection seniors are provided is that they cannot be turned away during annual open enrollment periods. But at the same time they cannot change plans if they get sick and are not satisfied with the providers’ networks during the contract year.

The New York Times’ “Choosing a Policy to Cover What Medicare Doesn’t” reports on how expensive and complex the process of acquiring Medigap coverage is. After a 6 month open enrollment period, state insurance laws control whether policies are medically underwritten and other consumer protections. With a few exceptions open enrollment starts with Medicare eligibility and is never repeated. This leaves the Medigap route even more difficult to navigate than Medicare Advantage.

Medicare controls the minimum benefits for 12 model Medigap plans (A-L), but not the cost of premiums. Medigap “Select” plans restrict benefits to the insurers’ networks. Outside of networks, Medicare co-pays are not covered. But even with Select seniors are protected from the price gouging that can occur outside the Medicare Advantage networks. Given that Medicare does not allow balance billing, Medigap coverage might not make any economic sense anyway.

Pete Peterson’s (Blackstone Group co-founder) Financial Times commentary “Questions America must ask on health costs” states that 30% of Medicare expenditures are for end of life care. Regardless of whether public opinion feels this is justified, the real issue for Medicare Advantage providers is have they been able to eliminate seniors from their memberships before the final year of life?

Since I am not a senior, I have not experienced either basic Medicare or Medicare Advantage. But if I could buy my way into to basic Medicare, I would gladly surrender my private insurance.

Allowing private insurers to engineer their networks and benefits to exclude the worst risk seniors while costing the government more is no benefit to either the seniors or the government. The only reason that Medicare Advantage has any popularity at all is that a constantly growing population predicates a constant flow of younger healthier seniors.

My conclusion is that seniors should stick with basic Medicare and not purchase Medigap. Save the Medigap premiums to pay for Medicare co-pays and deductibles. Seniors – stay with the ultimate choice – virtually every doctor and hospital in the country. And to the health reformers in Washington, I say open Medicare to all so every American has the ultimate choice!

It’s time to sell Humana (HUM), UnitedHealth (UNH) and WellPoint (WLP) before this Medicare Advantage and overpriced Medigap Ponzi scheme comes to an end.

No Disclosures.

The Ultimate Story Stock: A123 Systems

2009-10-07T15:29:00.005-04:00

Published by clickbroker.blogspot.com.

Short of Google (GOOG), IPOs don’t get any sexier than A123 Systems (AONE). No one disputes the potential of battery powered cars, massive storage of green energy from solar and wind, and having virtually every appliance from lawnmowers and vacuum cleaners to computers and entertainment cordless. But in the words of the internet, A123 is more eyeballs than monetization.

To be sure they have actual revenue, but they are running a negative gross margin on product sales. In essence the more they sell, the more they lose. And they predict the revenue from their largest customer Black and Decker (BDK) is expected to shrink considerably. No more revenue is expected from Mercedes-Benz (DAI) HighPerformanceEngines (Vodafone McLaren Mercedes Team). That leaves only BAE Systems (BAES.L) for growth.

The truth is in the prospectus. The only real-life applications besides power packs for hand tools have been: BAE Systems’ Hybridrive propulsion system for busses and a few Hybrid Ancillary Power Units for the AES Energy Storage unit of AES Corporation.

Here’s where it gets interesting. A123 is designing and developing batteries and battery systems for BMW, Chrysler, GM, Shanghai Automotive (SAIC), Delphi and Better Place. While A123 invests in custom automotive research and development, they expect most of their revenue for the “foreseeable future” from very few customers. And none of the potential automotive customers have committed to long-term contracts or minimum production volumes. So far A123 is much more hype than substance.

I cannot judge whether A123’s technology is superior to its competition. But it has some fierce competitors: Bosch, Dow Chemical (DOW), NEC, Panasonic, Sanyo and Samsung. Nissan (NSANY), Toyota (TM) and Volkswagen have entered into joint ventures to produce batteries that don’t include A123.

A123’s major manufacturing facilities are located in China and Korea. Their key strategy is to reduce cost by starting to manufacture in Michigan. Makes sense to me; lower costs by moving production from low cost countries to a high cost state in a high cost country. It only makes sense when the government gets involved in this Ponzi scheme.

The US DOE Battery Initiative granted A123 $249.1M to build manufacturing facilities in Michigan. The company also believes that it will be able to borrow up to $235M from the Advanced Technology Vehicles Manufacturing Loan Program. The company expects to be required to invest 25¢ for each DOE Battery Initiative dollar. In addition, the Michigan Economic Growth Authority (MEGA) granted $10M and offered up to $4M in loans. MEGA is topping their deal with a 15 year tax credit. Even the government can’t resist something this sexy.

Product revenues were $53.5M in 2008 and $36.6M in the first 6 months of 2009. But cost of product sold was $70.4M and 39.2M respectively. Throw on operating expenses of $79.6M and $40.3M, and you get losses of $80.5M for 2008 and $40.7M for H1 2009. With no definitive volume automotive contract in the near future, it looks like A123 is a pipe dream.

It might be helpful to view a speculation on A123 like a small biotech. Though, I take A123 more seriously than the ethanol debacle. No doubt green energy needs smoothing and electric cars will be a reality. But will A123 survive long enough to benefit? While automotive is the highest profile application, it is too much like what General Electric (GE) calls “long cycle businesses.” A123 will need to concentrate on less sexy applications to keep the company going until the brass ring comes in.

I might speculate on A123 when they break even on a gross margin basis and the hype in the stock is deflated. The trick is to enter when the fundamentals start to look like a viable business, but before the first major automotive and power grid deal is announced.

Disclosures: Author is long GE; GE has made an investment in AONE.

Both Health Insurers and Consumers will Cherry Pick under Reform

2009-10-05T15:25:00.001-04:00

Published by clickbroker.blogspot.com.

The Washington Post’s “Discrimination by Insurers Likely Even With Reform, Experts Say” subtitled “Economic Pressure Could Give Rise to New Biases Against Prior Conditions” sites many distinguished academics warning of cherry picking continuing under health reform. The professors predict that private insurers will employ a series of creative carrots and sticks to achieve the most favorable risk pool composition within the umbrella of guaranteed issue and no exclusions for preexisting conditions. I will argue that these practices might actually benefit the astute consumer.

Insurers are currently paid between approximately $800 and $2000 per month for Medicare Advantage seniors according to discussions in the recent Senate Finance Committee healthcare markup. Insurers are reimbursed the most for chronically ill seniors, but they cannot turn any senior away. The insurers maintain profitability charging a premium seniors are willing to pay by maximizing reimbursements and minimizing their actuarial risk. Humana (HUM) said during its most recent earnings call that they have to do a better job of identifying seniors in their risk pools that qualify for higher government reimbursements.

The professors predict that by offering gym memberships and limiting network doctors that specialize in high cost oncology and cardiology, insurers are able to encourage and discourage participants in their risk pools. In Florida, all Medicare Advantage recruitment events are in drive-to locations. The insurers never visit senior communities or nursing homes. The insurers recruitment skills honed in Medicare Advantage will now be applied to the general public.

The key to survival of the private insurers is to create generally affordable products and avoid or limit high cost consumers. If their risk pools are too high, the premiums will be unaffordable. So even though the goal of healthcare reform is to spread risk, the goal of the insurers is still to segregate risk. Karen Ignagni, president of the insurer lobbying group America’s Health Insurance Plans, is trying to promote a diversity of benefit products to segregate the population into multiple risk pools.

The next step is for the insurers to market to the best risks. This is the most subtle form of cherry picking. The consumer’s job is to buy insurance from the lowest actuarial risk pool and secure the lowest premium. The maximum out of pocket will be held to between $5000 and $6000 per individual and double that for families. But the composition of network providers, deductibles and co-pays will drive the risk pool for each plan.

The premiums within each product can vary by only by age, location and a few other criteria; not the medical condition of applicants. However, there are no limits to premium differential between products. Consumers who were previously either rejected or up-charged for minor infractions such as slightly elevated cholesterol or blood pressure will now be able to buy their way into the lowest risk pools and pay the lowest premiums.

Whether the government tightly controls benefit packages or not, consumers can seek out products marketed to the healthiest applicants. Insurers won’t be able to turn them away. This is where the cat and mouse games begin.

Obviously, lower deductible plans would be more appealing to sicker patients as would more compressive networks. To avoid gaming the system, consumers might be limited to changing products only during open enrollment periods like Medicare and Medicare Advantage. But given that the maximum out of pocket risk would be relatively low in all products, consumers can buy cheap now and switch when they need to.

The biggest risk to consumers is balance billing for out of network providers. This is where an out of network provider charges consumers the difference between their retail rate and whatever the consumer’s insurer chooses to reimburse. A limited network increases the risk of needing such a provider and there are no government plans to limit balance billing. This is why a government option for all based on the Medicare model is best. Medicare forbids balance billing.

I think the insurers will be pretty good at estimating the risk pools of each of their products. But outliers such as a high deductible consumers costing over $100K in medical expenses will exist.

In summary, both sides will be cherry picking. With guaranteed issue consumers are close to but not quite being equal warriors. Let the games begin.

No disclosures.

GE CEO Jeffrey Immelt Misdirected

2009-10-03T16:01:00.010-04:00

Published by clickbroker.blogspot.com.

The New York Times’ “G.E. Chief Sees India Helping Cut Costs of U.S. Health Care” reports that Jeffrey Immelt predicted that India’s role in reducing US healthcare costs will be significant. The comments were made by General Electric’s (GE) CEO during a news conference related to GE’s healthcare business restructuring in India. He predicted that India’s healthcare industry will grow to $75B by 2012.

Given that GE’s healthcare business is still way too dependent on the medical imaging “big-iron”, it is not surprising that Immelt’s comments focused on outsourcing the interpretation of these images. Creating a cheaper operating infrastructure to support the big-iron is favorable to selling more machines. Obviously, GE wants to do whatever possible to sell more machines and lowering someone else’s revenue will not affect GE’s profits.

GE continues to be shortsighted and selfish in its view of healthcare. I am disappointed as a shareholder that GE is not exiting or substantially shrinking their imaging business. GE’s imaging business is as over reliant on government subsidizes for senior care as Humana (HUM). It is just that Humana’s subsidy is direct Medicare Advantage revenue and GE’s subsidy is revenue to their doctor and hospital customers. These companies should heed what happed to the banks, for they might get feathered without even being TARPed.

Trouble with healthcare is not that the US is undersupplied with medical technology, doctors, hospitals and drugs; we are too far oversupplied. And seniors are no different than street drug addicts, they can never get enough doctoring – whether it’s beneficial or not. What Americans need more of is unbiased advice. Is a cancer patient better off suffering for 2 to 5 years under chemotherapy or living his remaining life peacefully with just pain therapy?

America’s addiction to healthcare is often justified in rhetoric about rationing, waiting lines and technology. As long as the arguments continue; companies, doctors and hospitals will continue to avoid preparing for a reduction in demand. Pfizer (PFE), Merck (MRK) and others will seek mergers, GE will do nothing and demand will start shrinking. The bill for healthcare reform will force us to break our addiction and rational use of healthcare will emerge.

Breaking any addiction is difficult and going cold turkey can be devastating. The Genentech-Roche model is going to be just as obsolete as GE’s. In addition to a newfound emergence of cost-benefit will be patient centric suffering-benefit. Are multiple years of suffering under the breast cancer drug Herceptin worth a short life extension?

Government’s role is to fill in the gaps left by the absence of profit motive. The suffering-benefit equation has not been well balanced by either the private sector or the FDA, and doctors are biased toward extending life at any dollar or suffering cost. Doctors’ role as scientists often conflicts with the patient’s desire for wellbeing. Government needs to fill this void. While choice would definitely encourage substantial cost savings, unbiased advice by government should not be interpreted as “death panels.”

GE must understand the shrinking healthcare demand will not be based on the economic cycles alone. The next generation of seniors might not take every treatment just because it’s free and the government will encourage this new refreshing attitude.

Disclosures: Author is long GE and PFE.

Business Trends: Canadian Healthcare Exaggerations, Medical Foods, Opaque Banking, FHA and WSJ Gold Stars

2009-09-21T15:48:00.003-04:00

Published by clickbroker.blogspot.com.

Cracks in Canadian Healthcare Poster Child’s Story
Bloomberg’s “Canadian Health Care, Even With Queues, Bests U.S.” reports that “allegations [against the Canadian health insurance system] are wrong by almost every measure, according to research by the Organization for Economic Cooperation and Development and other independent studies published during the past five years.” Canadians live longer and have equal survival rates to the US in major diseases like heart attacks and cancer, at an insured cost per patient that is 47% less.

Preventable deaths and infant mortality are both lower in Canada. Both countries ration care: Canada by wait times and the US by cost. A 2008 survey by the Commonwealth Fund showed 54% of chronically ill Americans delaying care due to cost, including both doctor visits and drugs. While Canadians typically have to wait for non-critical medical procedures and operations, they consume only one fourth as many high cost medical images as the US. The US provides financial incentives to overuse medical technology.

Both political sides can tailor statistics to make their argument, and I don’t know how the numbers would come out if the US excluded their noninsured and under insured. Canada’s system can best be described as Medicare for all regulated and administrated at provincial or state level. Doctors are mostly in private practice – hardly socialistic. Canadians are far more satisfied with their system than Americans. If Canadians were dying in the streets I’m sure Glenn Beck and the rest of the FOX News team would let me know.

Now for the fading poster child of the American right: 45 year old Canadian Shona Holmes was told she would have to wait 99 days to have a slow growing benign cystic brain tumor removed in her local hospital. If she was willing to travel 10 miles the wait would have been reduced to 56 days and only a 36 day wait for a 460 mile journey. Instead she chose a 2237 mile journey and a $97K bill to go to the Mayo Clinic in Scottsdale, Arizona. Sounds fishy to me.

Now Shona wants to be reimbursed by the provincial government because traveling within Canada was inconvenient. How many Americans can go outside their private insurer’s network and expect full reimbursement? For a slow growing tumor I doubt that time was of the essence, especially if treatment within Canada would be available in about a month. Shona wanted to go “out of network” and she deserves to pay the full cost. While we should not feel any sympathy for her, we should not exploit her either.

Shona, understand that you are being used by the American right and they will discard you when our healthcare fight is over. But Shona, you should feel shame for speaking ill of your country and exaggerating the urgency of your condition just to gain your15 minutes of fame in a 60 second political commercial.

My message to the right is that if you are against the constraints of private or government provider networks than you should be trumpeting traditional Medicare over Medicare Advantage. The only advantage to Medicare Advantage is a severe financial spanking for going out of network. Total healthcare freedom is Medicare for all.

Can anyone tell me how long Shona had to wait for her operation at Mayo Clinic and whether she has been receiving satisfactory follow up care in Canada?

Beyond Cheerios
General Mills (GIS) got into a little trouble with the FDA for overstating the benefits of Cheerios in fighting high cholesterol. But now the French company Danone is ready to enter the world of serious medical foods. The Financial Times’ “Danone hails HIV trial breakthrough” reports the company claims it achieved a breakthrough medical nutrition trial targeted at the immune system of HIV patients. Last year Danone started a similar trial aimed at the nutritional needs of Alzheimer patients.

Given that we all have small traces of cancer kept in check by our immune system most of the time, I would like to see non-pharmaceutical methods of immune system enhancement in clinical cancer trials. Could cancers still evade a super-charged immune system? A double-blind chemo vs. nutrition study would be fascinating.

The synergies between food and medicine will raise the stature of serious research based food companies and force pharma into the business. True value adding food companies should see increasing margins, leaving the remaining package foods companies to experience continued margin decline.

Yields and Banking
The Wall Street Journal’s “Don't Trip in Your Search for Higher Bond Yields” reports that Vanguard’s customers are stretching both credit risk and interest rate risk (duration) to achieve yield in a zero-rate Fed environment. At the same time the Financial Times’ “Citadel and CME scrap platform plan” reports that investment banks have lost interest in an exchange for standardized CDS contracts being pushed by regulators. Under such an arrangement, the exchange would be the counterparty to all transactions and the participating investment banks would back the exchange.

ICE has begun clearing some CDS transactions for JP Morgan (JPM) and Goldman Sachs (GS), but the investment banks are facing the same yield constraints as consumers so protection of the opaque is critical to maintaining profits.

FHA Watching Mortgage Originators
The Wall Street Journal’s “FHA Will Tighten Credit Standards” reports that mortgage originators will have to increase their net worth from a minimum of $250K to $1M. FHA wants to make sure it will be compensated when it purchases loans that are later proven to have not met their quality standards. In addition new rules for income verification and appraisals have been implanted.

Abbott’s Gold Star belongs to Isis
The Wall Street Journal’s “The Wall Street Journal 2009 Technology Innovation Awards” selected Abbott’s (ABT) Ibis Biosciences’ T5000 sensor as its gold winner. Abbott completed the purchase of the Ibis Biosciences unit from Isis Pharmaceuticals (ISIS) on January 6, 2009 and Isis will continue to receive royalties of up to 5% on both equipment and supply sales.

The Ibis Biosensor identifies pathogens by molecular weight and mass spectrometry without having to know in advance what you’re looking for. Its development was primarily funded by the government using Isis technology. The Naval Health Research Center used the system to identify the H1N1 swine flu virus. 20 systems are already deployed including the Centers for Disease Control.

The real future market lies in hospital born viruses and bioterrorism. Since hospitals are not reimbursed by insurers for problems of their own making, early identification and remediation is critical to hospital profitability.

Discloser: Author is long ISIS.

Gold, the Money Supply and Inflation

2009-09-14T13:30:00.000-04:00

Published by clickbroker.blogspot.com.

Liaquat Ahamed’s book “Lords of Finance: The Bankers Who Broke The World” unraveled every misconception I had over the gold standard and inflation. The book traces the central banks of the United States, the United Kingdom, France and Germany from before World War I until the close of World War II. So far I have read the book through the year 1928 and would like to share some thoughts.

The story is told primarily through the eyes of Benjamin Strong (Federal Reserve Bank of NY), Montagu Norman (Bank of England), Emile Moreau (Banque de France) and Hjalmar Schacht (Reichsbank). During the first half of the 20th century European countries had been on and off the gold standard several times and have had severe bouts of both inflation and deflation. Gold stockpiles have been maintained by central banks, government treasuries and large private banks. Currencies have been pegged to gold, other currencies, and even land.

Prior to World War I, the supply of gold increased with the economies of the major European nations so gold basically kept the money supply in line with GDP and inflation in check. The US was short on gold and borrowed heavily from Europe. By the conclusion of World War I, the tables have turned. The US had a disproportionately high amount of gold to its GDP and the UK, France and Germany were severely deficient gold. The UK and France not only paid for war supplies in gold, but also incurred substantial debt to the US. And Germany was stuck with reparations beyond its economic capacity.

The UK chose to deflate its economy to match its reduced gold supply, and incurred the suffering of high unemployment. The British wanted to reassert the pound as the world reserve currency. France chose moderate inflation and economic growth while rebuilding its gold supply. Germany chose hyper inflation with no backing of its currency at all.

The US lent gold to all three nations once Germany issued a new currency backed by land. All three nations had stable currencies by the 1920’s backed by owned and borrowed gold. But reparations still hindered Germany’s economic growth. And the UK and France fought for dominance of European finance.

When the US increased its money supply in relation to its increased gold supply, moderate inflation ensued. So when gold flowed between countries disproportionately to their GDPs, currencies did not function as a constant store of purchasing power. In reality, the more gold the less purchasing power of the currency.

Early central bank theory was that lending based on commodities or other hard assets was safer. But this proved as false in the early 20th century as in our recent housing bubble. Assets in focus receive more financing which inflated their prices, giving a false sense of collateral.

Modern currencies are primarily based on GDP, with some tier 2 economies pegging their currencies to the US dollar. Unfortunately, modern central bankers don’t want to match money supply growth to a moving average GDP. They want money supply growth to lead economic growth creating an inflationary bias. This has been a slight or heavy bias depending on who’s in charge. (Paul Volcker vs. Alan Greenspan and Ben Bernanke.)

From the investors perspective the question is how does one store purchasing power? Gold even at its multi-decade high has not matched inflation. And gold has faced many bouts of competition from commercial and residential real estate, oil and food commodities among other hard assets. All hard assets incur storage expense as well as lost income opportunity cost for the money invested. Even the diehards have to admit it would be difficult to trade your gold for bread at the supermarket.

My conclusion is that there is no hard asset that can store purchasing power. Not gold nor anything else. If the economy tanks gold is useless. If you believe that over time interest rates follow inflation, then the carrying cost of gold in lost opportunity cost is the greatest when you would desire gold the most.

Trigger happy modern central bankers keep fluctuating interest rates and Wall Street is constantly running a beauty contest between sectors. Long term investors should lock in quality high interest rates during bouts of high inflation, even if that would incur a temporary negative spread with purchasing power. Inflation ebbs and flows.

Long term investors should also focus on the Select Sector SPDR ETFs to buy the most out of favor sectors one at a time. This would avoid some of the complete wipeouts seen in the financial sector recently and materials sector in previous decades. Think WaMu and Bethlehem Steel. When Wall Street rotates your sectors to the front of the dance hall, you are a winner. In the meantime you’re collecting dividends.

The Select Sector SPDRs are: Consumer Discretionary (XLY), Consumer Staples (XLP), Energy (XLE), Financial (XLF), Health Care (XLV), Industrial (XLI), Materials (XLB), Technology (XLK) and Utilities (XLU).

The sectors provide an interesting opportunity for a reformed bottom fisher in individual stocks. You get to bottom fish sectors while playing the momentum within each sector. This is because the S&P 500 sectors market weight the stocks within each ETF.

My concession to those that run real estate as a positive cash flow business is that you might be storing purchasing power in your assets, but that is not the primary reason for your success.

No disclosures.

Wall Street Securitizations Reincarnated for Life Settlements

2009-09-07T19:14:00.004-04:00

Published by clickbroker.blogspot.com.

The New York Times’ “Wall Street Pursues Profit in Bundles of Life Insurance” reports that Credit Suisse (CS) and Goldman Sachs (GS) are gearing up for wagers that would even make Sarah Palin’s “Death Panels” cringe. The new game in town is securitizing life settlements on a scale as massive as subprime mortgages to reap the same level of fat fees.

The $26T of life insurance policies is certainly temping compared to a peak 2005 $941B of Wall Street mortgage securitizations. Mortgage securitizations dropped to $169B year to date and Morgan Stanley (MS) estimates the repackaging of old CDO (read credit challenged) tranches should exceed $30B. The trick once again is to fool or bribe the ratings agencies into granting triple-A status to the life settlement trusts. Moody’s (MCO) has not seen a portfolio that qualifies.

The life insurers are concerned that their modeling of policies lapsing before death might no longer be valid if life settlements gain momentum. If a policy holder has the guaranteed right to renew but either no longer needs the benefit or can no longer afford the premium, no payout is required. However if most policies are active until death, higher premiums across the board would be required. Likewise the tax treatment of life insurance might change if it’s viewed as a negotiable (tradable) asset.

The insurers might also start taking a hard line and challenge payouts on policies that appear to be fraudulent. Regulations vary by state, but the policyholder generally should have an insurable interest. Policy values greater than the estate are questionable. Also commission rebates to pay applicants for the trouble of going through a medical exam for a policy that will be sold directly back to the insurance broker has questionable legality.

Following the subprime methodology, Credit Suisse has purchased an originator and is building a high throughput assembly line. Next to come should be independent brokers and warehouse financing. The complexity of state by state insurance regulation and the diversity of life insurance products could lead to much more difficult underwriting than even the most complex mortgages. Whether it is the time needed to conscientiously underwrite settlements slowing down the assembly line, or numerous mistakes and frauds to speed it up, either way trouble is brewing.

But the real difficulty lies in an insurance industry unwilling to cooperate. There is a conflict of interest between insurers and the other parties. Unlike the mortgage model where everyone benefited from the fraud except investors; the insurers see only more payouts. Additionally, securitization will negatively impact the affordability of their products and subsequently reduce their potential customer pool.

Investors in these securitizations will also face their share of risks. With a limited supply of viatical settlement eligible (terminally ill) policyholders, the machine will focus on life settlement agreements for the aging and health deteriorating policyholders. Risk management such as a diversity of diseases in the portfolio is being studied.

While the trusts are waiting for benefit payouts, they must continue to pay the policyholders premiums in addition to the initial settlements. Depending on the securitizations’ initial capitalization and the timing of premiums and benefits, investor cash calls might be required. Investors might also be deceived by fraudulent underwriting such as overpaying for settlements and overstate disease severity so that the originators can complete the sales and earn commissions. Sounds just like subprime.

A black swan such as curing cancer, diabetes and heart disease in one magic pill might cause all models to blowup. Keep in mind the Holy Grail for all pharmaceuticals are to harness the immune system, so don’t say it is not possible. And Sarah Palin’s worst nightmare Obamacare might even cause life expectancy to increase dramatically. Goldman Sachs is creating a tradable index to hedge this risk or simply bet on life expectancy.

The startup of this machine should be a clear warning to Federal Reserve Chairman Bernanke that interest rates are way too low. The Times says that pension funds and other large institutional investors chomping at the bit to get in. Is history repeating itself?

You’ll know when there is trouble when retail investors are invited in and institutions try to bailout. After all is that not the purpose of the newlyweds Morgan Stanley Smith Barney?

By the way, can anyone tell me how the securitization trustee knows when the policyholder has transitioned? It not like a spouse, child, friend, business associate or other relative beneficiaries were keeping tabs on the deceased or even attending the death bed. Obviously non-beneficiaries don’t care whether the trust gets its payout.

Disclosure: Author is long MCO.

Business Trends: Banks, Cars, Healthcare and Safe Vermont Mortgages

2009-08-25T18:35:00.005-04:00

Published by clickbroker.blogspot.com.

The Strong
The Wall Street Journal’s “Slump Spurs Grab for Markets” reports that strong companies like JP Morgan (JPM), Bed Bath and Beyond (BBBY), and New York Life have used the turbulent market to annihilate their competitors. JP Morgan is stealing cheap deposits from weaker banks, Bed Bath went in for the kill on invalid Linens‘n Things, and New York Life is out selling AIG (AIG), Hartford (HIG) and Lincoln National (LNC) in life insurance and annuities.

All three of the winners cited by the Journal were strong entering the crisis and deserve their outcomes. But do Bank of America (BAC) and Wells Fargo (WFC) now deserve to control nearly half of the mortgage origination market? And does Citicorp (C) still deserve to be the preeminent international transaction banker?

Financial firms differ from all others in that confidence is a matter of life and death. Bloomberg’s “Bank of America Said to Balk at Paying Backstop Fee” reports the government seeks value for its willingness to backstop $118B of Merrill Lynch’s more difficult assets, even though the deal was never consummated. The original agreed fee was $4B. It could be argued that willingness from an institution as strong and powerful as the US government had economic value that was reflected not only in Bank of America’s share price, but in its very survival.

All of the banks that I mentioned are members of the top 19, deemed too large to fail. This group gets added value that should be paid for. The Fannie Mae (FNM), Freddie Mac (FRE) and AIG precedent of protecting all bond holders, including junior unsecured, for full principal and interest has allowed all 19 to access the debt market relatively unencumbered. Even Citigroup will soon be forced to leave the nest of FDIC guaranteed commercial paper and debt.

Equally important with the ability to float debt is the ability to retain large deposits. These 19 banks have implied FDIC deposit insurance beyond $250K for interest bearing accounts. Why shouldn’t they be required to pay for that implied deposit insurance?

The Obama Administration is proposing additional oversight and regulation on financial institutions deemed too big to fail. This would definitely add cost, but that price is not high enough for admission to sit under the government’s protective umbrella.

The Disingenuous
The Wall Street Journal’s “SEC Plays Keep-Up in High-Tech Race” reports that the agency lacks the technical expertise to collect and analyze data on the way financial markets actually function. The SEC is reliant the exchanges for alerts and deep data dives. It cannot directly determine the effect of restricting flash orders or dark pools on share pricing.

I say that the SEC does not need proof to determine right from wrong or good public policy. Former Fed Chairman Greenspan never acted to prevent bubbles because he never had any proof they were forming, or that “financial innovation” could cause any serious harm. And former SEC Chairman Cox was even too resistant to even look for evidence of potential harm.

The Journal’s “Can Mercedes Keep Its Luxury-Car Edge?” reports manufacturers that sell less than 400K cars per year in the US are exempt from the new tighter fuel economy standards. This neither benefits the specialty brands nor our country. Pricing at the luxury end allows for real leaps in material science and other technologies for true innovation.

Image if the Lexus LS were required to get an average 35 miles per gallon. Lightweight large cars would become commonplace, and the technology would trickle down to Toyotas (TM) and Chevys. Instead we’re on the same old path of either small and efficient, or large and inefficient - no real change.

The Journal’s “Vermont Mortgage Laws Shut the Door on Bust -- and Boom” reports that while the state’s restrictions prevented mortgage abuse, the restrictions also kept “qualified” potential homeowners from achieving their dreams and stunted the state’s growth. Vermont’s economy grew 60% over the 10 year period ending in 2008, just 3% less than the national average. Think what Florida could have learned from Vermont.

The New York Times’ “Calm, but Moved to Be Heard on Health Care” reports that Bob Collier (62) believes: “We’ve got to do something about those people who can’t get insurance. There has to be a safety net there. But I don’t want that safety net to catch too many people.” Collier, who gets his news from Fox News, Rush Limbaugh and Matt Drudge, claims that he is genuinely concerned about the federal deficit and lazy freeloaders.

What makes Collier’s protest at Democratic Representative Bishop’s town hall meeting disingenuous is that his wife of 35 years had breast cancer and is uninsurable if he loses his job. But his fear of healthcare rationing during his Medicare years outweighs his fear of losing insurance coverage before he and his wife get there.

Collier’s employer Buccaneer charges him no premium but he pays $509 per month to cover his wife. Their out of pocket costs are rising 15% per year and deductibles are up 400%. $63K of his wife’s treatment was considered experimental and billed to the Colliers. But miraculously Emory Healthcare agreed to write off the charges.

If Collier actually had to write a check for $63K or face bankruptcy would he feel differently about healthcare reform? Would he be more concerned about his grown children and grandchild’s ability to get healthcare than an uncontrolled federal deficit? Collier should know that his wife’s cancer will forever prevent his offspring from getting medically underwritten insurance. (The underwriting process involves medical question about blood relatives.)

Lastly, does Collier think that individuals should be given the same protections as he gets in a group plan?

The Creative
The Wall Street Journal’s “With Money Tight, a Bank Takes Parmesan Cheese as Collateral” reports that an Italian bank watches over its collateral in its own temperature controlled warehouse. The 85 pound wheels are each stamped with the month and location and a certificate is issued to the borrower to secure a loan. The tradition dates back to after World War II.

Disclosure: Author is long BAC, C, FNM, FRE and WFC.

You can keep your Doctor if your Employer and Union Say So

2009-08-17T21:07:00.002-04:00

Published by clickbroker.blogspot.com.

The Sun Sentinel’s “School employees protest possible insurance switch” reports that 150 of Palm Beach County (FL) School District’s 21,000 employees have grave concerns with the pending switch from UnitedHealthcare (UNH) to BlueCross BlueShield of Florida as the administrator for their self-insured plan. Superintendent Art Johnson said the agreement with the union will save employees approximately $30 per year.

School districts in Florida are countywide, so they represent big business in the context of the state. The district pays 100% of the “premiums” for employees and 60% for an additional 14,000 receiving dependent coverage.

The interesting part of the story is that the plan administrator rather than the self-insured employer chooses the doctors and hospitals in the network. UnitedHealthcare has 950 primary care physicians in Palm Beach County while BlueCross only has between 400 and 500. BlueCross says it has already convinced 22 of the 87 most used providers to join its network. But that’s not good enough for employees that have developed trust in their doctors.

The newspaper gave an example of an employee with a difficult to diagnose condition that is fearful of starting over with a new doctor. The importance of the article is that patients have very little security in maintaining their doctor relationships, regardless of the outcome of healthcare reform.

No politician, left or right, can guarantee that you can keep your doctor or your health plan. This is true even if you don’t change jobs. So let’s evolve beyond the dreamland of Ozzie and Harriet and Father Knows Best.

School board member Monroe Benaim (an eye doctor) was even rejected from joining the BlueCross network. Unsympathetically, he advised employees to go out of network to stay with their preferred doctors. Such irresponsible advice opens employees to the risk of balance billing.

The final board has a final vote on the issue scheduled in two weeks.

No Disclosures.

Rational Market Theory and Black Swans in Healthcare

2009-08-16T22:15:00.001-04:00

Published by clickbroker.blogspot.com.

Whether you are a believer in the rational market theory or black swans, you could see that even former SEC Chairman Christopher Cox would have cause to blush at the healthcare marketplace. Cox was the champion non-interferer in charge of enforcing a level playing field for investors large and small.

So the question is can our current healthcare marketplace be modeled by rational market theory, black swans, or neither? Rational market theory is based on current security prices reflecting all available information. Perhaps the only more opaque marketplace than healthcare is derivatives. I’d call it a tie.

Patients cannot even get committed pricing from doctors and hospitals, let alone be on an equal footing to negotiate. Marcus Welby, M.D. television fans looking for a sympathetic doctor are stuck in the 1970s with their heads in the sand.

Those black swans, uninsurable patients, are left to go bankrupt or die. Private insurers have removed black swans from their membership. When they appear those member’s policies are rescinded. The only black swans that remain are either on Medicare, Medicaid, or employed by large self-insured companies and governmental entities.

So before any intelligent discourse can begin, opponents of healthcare reform must admit that a level playing field in the SEC sense cannot be developed unless every citizen is insured or no citizen is insured. And all must be insured at roughly the same level. You cannot have a cash market and an insured market at the same time. This has been the failure of Republican instituted high deductible insurance policies.

When conservatives argue that the private insurers cannot compete with the government, they should also argue that a cash market cannot compete with the private insurers. Cash buyers pay typically two to ten times the private insurer and government reimbursement rates. This alone is proof of my all or no one theorem. Individuals must pay ridiculously high premiums, with up to $5000 deductibles just to pay hospitals insurer negotiated rates. Even Cox would call this extortion.

I felt compelled to write this article after carefully reading Merck (MRK) and Schering-Plough’s (SGP) advertisement in my Sunday newspaper. The soon to be merged companies state in bold type: “Vytorin has not been shown to reduce heart attacks or strokes more than Zocor alone.” Zocor is already available as a generic, so you would have to be brain dead to believe that any participant in a rational free market would select Vytorin without adverse financial incentives to doctors and patients. And that’s without even considering the potential adverse affects of Vytorin.

As the rhetoric is getting hotter, I would like the opposition to either come to the table with rational cash market regulation or stop fighting minimum standards for the entire citizenry to be insured. The courts have been of little help in protecting patients against extorted prices. “Financial responsibility” contracts signed in the emergency room should certainly be viewed as “beyond the conscience” of the courts. Lawyers, please help me understand.

While Sara Palin sings to choir, other flamboyant orators will soon face burnout. Let Whole Foods CEO John Mackey tell me how all citizens can buy into his company’s health insurance to create a level playing field. Let FOX News (NWS/NWSA) tell me how to create a rational cash market.

Glenn Beck lectured before three cardboard cutouts Saturday night on how debasing our currency will lead to a fascist takeover of America similar to Germany in the 1930s. The implication being that President Obama is the new Hitler and healthcare reform is the mechanism for the revolt. Government will deny care to babies and grandmas that have little economic value to save money as the country is drowning in debt. And the green movement will kill the unborn to save the planet from overpopulation.

Not only is FOX News losing sponsors for Beck’s show, it also appears that top tier guests are refusing to participate. The Saturday show was loaded with public service announcements and promos for other FOX shows. I saw only one paid commercial per break. I am also seeing FOX News anchors only interviewing each other throughout the day on other shows.

Paid sponsors do matter. Sponsors temporally removed syndicated radio celebrity Dom Imus from the air for a racial snafu. And the lack of paying advertisers and real customers led to the end of the dot-com bubble. Eyeballs alone won’t save Glenn Beck.

The healthcare opponent rebel rousers already have sugar daddies. But what they share in common with Beck is the need to constantly raise the bar of outrageous commentary and behavior to keep the public’s interest. Sensationalism is like a drug to an addict; over time an ever increasing dose is required to keep the affect. Then the addict dies from overdose.

Finally, I am perplexed as to why President Obama is being blamed for debasing the currency and not Federal Reserve Chairman Bernanke. It is Bernanke who is actually monetizing the country’s debt, not the President. You see, this is not a battle about healthcare – it is an attempt to destroy the President. In this context no rational discussion of the marketplace can proceed.

While the opposition protesters appear far less sincere than the civil rights and antiwar movements of the past, I have never seen a President so dedicated to accomplishing his goals as Obama. This President is the most aggressive that I’ve seen in my lifetime. That is what really scares the opposition.

No disclosures.

Business Trends: Whole Foods, McDonalds and New Banking Fears

2009-08-14T13:13:00.002-04:00

Published by clickbroker.blogspot.com.

Whole Foods Attacks Its Base
Apparently Whole Foods (WFMI) CEO John Mackey has not learned the real political lesson from Karl Rove. Instead, Mackey chose to regurgitate Rove’s false rhetoric on healthcare reform in a long winded editorial in The Wall Street Journal “The Whole Foods Alternative to ObamaCare”. I won’t repeat the details here.

Mackey’s Darwinist vigor to destroy and swallow his competition has led to Whole Foods unquestionable success. Entrepreneurs become successful either by feeling invincible or being paranoid. Legend is that Intel (INTC) is the success of the paranoid. When Intel started becoming too fat and happy David (AMD) took a nice size slice out of Goliath. The last few years returned Intel to its roots.

Recently I wrote “WFMI Moves from Whole-Paycheck to Partial Paycheck”, convinced that Mackey was developing a healthy sense of paranoia by steering the company back to its core values. I confess that I spoke too fast. Mackey’s healthcare editorial tells me that he still retains an unhealthy sense of invincibility.

Mackey’s Darwinist theory of healthcare is surely to antagonize his highly educated, one might even say elitist target audience. How could a customer willing to spend extra so that the farm workers get fair wages not want health insurance for all? Yet Mackey is calling for the uninsured and uninsurable to kneel at the mercy of philanthropists or just do without healthcare and die as martyrs. After all, he says healthcare is no more a right than food or shelter.

It’s interesting that when I watch the most unruly and disrespectful participants in this month’s political town hall meetings I see only the most obese and unhealthy. Granting those any health insurance at all runs counter to both Mackey’s Darwinist and personal responsibility doctrines.

Trouble is Mackey doesn’t really understand how Rove got George Bush, Jr. elected president twice. Rove would espouse any policies that galvanized the base, his personal morals were irrelevant. Unfortunately, Mackey’s core values are as superficial as Rove’s. And I believe Whole Foods customers will revolt.

The real question is did Whole Foods board of directors approve an outburst by the CEO that was clearly against the shareholders interests?

Charles Schwab meets McDonalds
The Wall Street Journal’s “McDonald's Profit Declines” reports some dissention in the land of McCafés (MCD). Sensing fear from Charles Schwab’s animated commercials warning about discussing a complex trade with an inexperienced broker, “some franchisees … voiced concern over how well equipped the stores are to handle complicated coffee orders.” Fortunately, my trades are never so complex that I would need Schwab’s services and I actually stopped drinking coffee.

Banks at Liquidation Value
Bloomberg’s “Next Bubble to Burst Is Banks’ Big Loan Values: Jonathan Weil” reports that Regions Financial’s (RF) loans were worth $22.8B less than book value and shareholder equity was just $18.7B. This was a footnote disclosure in the 10Q according to Bloomberg. Bank of America’s (BAC) discrepancy was $64.4B and Wells Fargo (WFC) $34.3B.

The fair-value gaps are based on the accounting distinction between loans held for investment and loans held for sale. Loans held for investment can optionally be fair valued, but traditionally are valued at historic cost (less impairments and reserves).

Bloomberg is also reporting “Toxic Loans Topping 5% May Push 150 Banks to Point of No Return”. While the government told us that the nation’s top 19 financial institutions are “guaranteed” not to fail, Bloomberg has screened a list of 150 publicly traded banks with non-performers over 5% and almost 300 at 3% or more. Bank failures when non-performers reach 5% are not imminent if reserves are adequate, but trouble is implied.

How scary are these stories? First liquidating value of loans should not be a key metric as long as the banks can reasonably be viewed as going concerns. Almost no businesses, whether financial or industrial, has a positive liquidating value without goodwill. However, I do give value to the investment risk in banks topping 5% non-performing loans or being inadequately reserved. Bloomberg alerted me to this regulatory benchmark.

Disclosures: Author is long BAC, INTC, RF and WFC.

‘Cash for Clunkers’ Program will Exhaust Itself

2009-08-12T14:58:00.002-04:00

Published by clickbroker.blogspot.com.

The Wall Street Journal’s “Dealers Scramble to Find Fuel-Efficient Cars” reports potential shortages in the more popular higher mileage vehicles sought by the consumer stampede into the CARS (Car Allowance Rebate System) program. This super-hyped government program is the subject of endless advertisements by all of the domestic manufacturers. It is so hot that even the most demagogue conservative Republicans have had to put their ideology to rest.

The program’s popularity in the industry is rooted in its showroom traffic generation. Dealers can’t sell anything without customers, so any sense of excitement is welcome. And those that don’t qualify can be “bait and switched” with an alternate deal. All the news reels of clunkers being destroyed at the dealerships and contrived “worry” that program will run out of cash increases consumer anxiety to act now.

The news media continues to dispel the rumor that even the extra $2B just approved for the program won’t last through September. But I say calm down. Just like the tape recorder in the old “Mission Impossible” TV program, the CARS program will also self-destruct. That could be why its ideological opponents only pretended to put up a fight.

The first batch of clunkers came from a prudent set of consumers with high FICO scores. They most likely kept their clunkers because it was more economical to maintain rather than replace their vehicles. Sooner or later we will reach stage two when the remaining clunkers are no longer in strong hands. The clunkers left will be owned by consumers that have to drive a junker; not those playing the game of how long can I make this last for fun.

Even Warren Buffett traded his storied Oldsmobile for a new Cadillac a few years back. With fewer frugal Buffett protégés holding qualifying classics, the CARS program will either die of exhaustion or be modified. Either way, it won’t require new funding. Most likely money would be transferred from other parts of President Obama’s stimulus. This appears to be the only real economic action I’ve seen in any of the stimulus programs.

The real question is does the CARS program actually benefit consumers? The Wall Street Journal’s “Lawmakers Seek 'Clunker' Vouchers for Out-of-Stock Cars” and “Clunkers Prove Common, But Dream Cars Are Scarce” report that consumers are unlikely to have much bargaining power when they seek the maximum $4500 CARS voucher. They are likely to have to pay full sticker from the dealers or settle for their second choices.

Whether we are experiencing a mini automobile bubble or the effects of an airline style capacity reduction is unknown. But hysteria is never the right time for a consumer purchase. Clunker or not, it is highly likely that on a total deal basis consumers will fare better in the fall. Remember every car has some value to the junk yard, as long as the engine is not destroyed. (The CARS program required that dealers destroy the clunker’s engine.)

Previously I wrote "Fed Running Out of Credit Worthy Consumers". The government’s programs to add liquidity to the economy are useless unless the liquidity gets to the hands of consumers financially able to spend it. I draw the same conclusion with the CARS program.

While I’m honestly surprised that so many clunkers were held by credit worthy customers, I am again stunned that customers are fighting to get an end of model year car at virtually full price. But if you must, get that Pontiac before it’s too late.

WFMI Moves from Whole-Paycheck to Partial Paycheck

2009-08-05T15:01:00.001-04:00

Published by clickbroker.blogspot.com

Whole Foods (WFMI) emphasized that customers are beginning to recognize its value proposition during its recent Q3 earnings call. Customers that purchased the company’s “investments” in value items had larger baskets at checkout and visited their stores more frequently. At the same time management disagreed with analysts that the stores focused on a wealthier clientele.

Whole Foods claims they target the more highly educated, not necessarily the wealthiest customers. But along the way they ventured from being the basic organic grocer to the gourmet shop. The newer stores required ever higher capital expenditures and carried increasingly more expensive delicacies. Consciously or not, Whole Foods required an ever more high-margin (read wealthy) customer base to feed its growth.

Then came the worst recession since the Great Depression and as President Obama coined, Whole Foods had a “teachable moment.” CEO John Mackey unveiled the company’s new emphasis on customers that appreciate higher quality food rather than foodies that desire high priced gourmet.

Less high-margin customers translate into simpler stores that require lower capital expenditures. The marketing direction is to drive higher volume from lower cost outlets by convincing lower margin customers of the value in shifting their grocery dollars to Whole Foods. And when the customers’ grocery budget is not high enough for Whole Foods, the company needs to convince them to shift money from other expenditures.

When is it worth buying cheaper clothes, paying less rent or keeping your home appliances a little longer to enable you to shop at Whole Foods? With less discretionary spending available, that is the make it or break it question for the company. John Mackey realizes that Whole Foods can no longer depend on wealthy customers alone, and aspirational consumption has become out of favor. Look at the travails of the middle to high-end department stores like Macy’s (M) and Saks Fifth Avenue (SKS).

Whole Foods does not claim to know whether their better than expected results are a harbinger of an improving economy or unique to the company. Mackey repeated emphasized that more moderate growth led to higher margins, as established stores have the volume to profitably cover their fixed cost.

I think that Mackey is on target. If you believe consumer spending will be stagnant over the next few years, each retailer has to establish greater importance to its merchandise to gain a greater share of their customers’ wallets. Creating more average income customers that value Whole Foods definition of quality food is the only way for Whole Foods to continue to grow.

Previously I wrote that Whole Foods was in denial; I no longer think so.

No disclosures.

High-Frequency Trading Winners and Losers

2009-08-01T21:43:00.004-04:00

Published by clickbroker.blogspot.com

The Wall Street Journal’s “What's Behind High-Frequency Trading” provides a pretty good Q&A on how Goldman Sachs (GS), Citadel and various smaller specialty firms take advantage of advanced peaks at orders, exchange rebates and flash orders that can be withdrawn in a split second. A political furor is starting to emerge from highly leveraged firms front running orders and teasing prices fractionally up, at the expense of mutual funds and other large institutional investors.

With firms jockeying for the closest physical proximity to the exchanges data centers, NYSE Euronext is building a huge data center in New Jersey to accommodate them. The exchange will be renting space in its own multi-football field size data center to house the computers of high-frequency traders. That’s how critical the speed of light along fiber optic cables is to this form of making money.

Aside from some inherent unfairness, what has regulators and politicians concerned? First is leverage, especially with the small firms specializing in this extreme form of programmed trading. Second is the systemic risk of large trades gone wrong. Third is the cascading effect of copy cat strategies. Think of how seriously flawed the portfolio insurance schemes of the 1990s were when they encountered a few black swans.

While mutual funds and large institutions are marginal losers, the exchanges are obvious winners with increased volume. Typically institutional traders don’t use limit orders for fear of tipping their hand, so any market manipulation hurts their clients. In a very real way high-frequency traders, such as Goldman, are trading against their own clients.

The story is mixed for retail investors. Most firms no longer charge higher commissions for limit orders, so higher volatility increases the likelihood that retail orders will be filled. Investors that are not pressured to buy or sell in a certain time frame are clearly winners.

Retail “active” traders that favor market orders could be buying or selling at a slightly disadvantaged price. Also they could be fooled by a false sense of momentum.

Retail investors that are dependent upon gradual investment sales for living expenses are most vulnerable. It can also be said the retail mutual fund shareholders will suffer slightly lower returns. But, investors in low churn funders should not be concerned.

If regulators rein in on this form of front running and insure firms have the capital to cover their risk, I see little harm in high-frequency trading. In many ways high-frequency trading has the same risks and benefits as programmed trading on the news.

No Disclosures.

Aetna Message – Use Healthcare and Pay More or Receive Less

2009-07-27T13:12:00.002-04:00

Published by clickbroker.blogspot.com

Aetna (AET) treated us to a surprise early Q2 conference call Monday morning. Medical costs on certain commercial accounts substantially exceeded expectations. Not by more admissions, but by more higher-cost events to the tune of $10K to $30K per event. COBRA medical benefits trended to between 100% and 150%*. Medicare and Medicaid startup medical loss ratios also exceeded longer term trends. All this points to an acceleration in the rate of consumers deferring medical care.

Aetna also cited suspicious medical service providers that were billing for multiple procedures for the same medical event. Aetna intends to rewrite provider agreements to eliminate payment for multiple procedures, as well as increase auditing of these providers.

First Aetna cited economic conditions for these trends, than conceded that the trends are more secular than cyclical. Therefore Aetna will be re-underwriting the employers of “abusive” employees with higher premiums and eliminating reimbursement for multiple procedures by providers Aetna deems abusive or suspicious in claims coding.

Both increasing employer premiums on commercial accounts and restricting benefits (whether abused by providers or not) points to a greater trend of medical underwriting reaching employees. Employer groups that are less healthy or dominated by chronic or high cost medical events will actually get fewer benefits as their employer premiums go up.

Continuing this trend, as employers reduce benefits for the sickest employee groups, more sick employees will defer care. This will leave a much greater population of advanced diabetic and cancer patients to Medicare and Medicaid. Therefore, it is the government’s business to regulate health insurance because the government ends up paying far more for free market deferred care.

Employees with gold-plated health insurance should beware. Without government minimum standards, Aetna is telling you your care will be rationed. If your care costs too much, one way or another your access to health services will be restricted.

Everyone (both the haves and the have nots) really does have a stake in seeing that healthcare reform becomes a reality. Unfortunately, President Obama has not done enough to scare the haves into realizing they are truly at risk.

*COBRA breeds adverse selection because medically underwritten individual policies are generally cheaper for accepted applicants.

No disclosures.