In Defense of Ms. Whitney

Meredith Whitney came on strong yesterday in an interview with Maria Bartiromo, saying the market was overvalued and she had no idea why it was rising. I quote (roughly) "I am the most bearish I have been in a year." Ms. Whitney, in the past, has been a banking analyst with keen insight into housing, the cause of bank troubles. And banks led the market down, so the call is a natural since her view of housing and the banks is based on math, not hope, and it is probable the banks will lead the market down again.

She was immediately attacked by the man who never met a stock he did not like at some time or another - Jim Cramer - the world's worst stock picker. His attack not only lends credence to her views, it proves this is a trader's market that can only escape fundamentals for so long.

I met Ms. Whitney on a fateful day - the day she broke the bank stocks soon after she put out a report on Citicorp in October of 2007. Our conversation in the green room at Fox had me do my own research on the large banks - I had been recommending shorting the home builders and sunbelt banks since February of 2007 in my service, ChangeWave Shorts, and her passion and data convinced me the money center banks were next. She is what we all need - an agnostic - a fundamentals driven analyst. She was then and she is now -- and, over time, fundamentals did not lie - they drive stocks and markets.

In her interview with Ms. Bartiromo she pointed out facts known and ignored on Wall Street:

• Consumer credit continues to contract - credit lines are down $1.5 trillion, contraction is accelerating again and this will have a demonstrable impact on consumer spending this holiday season and the future.

• Home ownership is still at 67.8% of households as opposed to the pre-bubble, historical norm of 65% - I believe the real number is 63% - it does not matter, more and more people are going to become renters in the coming years. This means more foreclosed homes, more inventory, a continuing fall in consumer wealth. She did not say when housing prices will stabilize - I am a super-bear on this one and nationally I do not see real stability until the period between Q4 2011 and Q2 2012. She did mention that less than 1% of temporary loan modifications have resulted in successful permanent loan modifications.

• The Fed is now the mortgage market - they are the only buyer of mortgage backed securities (MBS) - and when they end their program, which is supposed to happen soon, rates will go up as there will no buyers. The money on the sidelines that may or may not be appearing in gold and in the stock market is certainly not coming back into mortgages for homes.

• The value of bank stocks will go back to tangible book value and that is not going to be nearly as high as expectations on Wall Street due to a weaker 2010 than expected. Banks also need to raise capital to pay back the TARP and cover future losses. Banks exposed to the consumer market are most needy and at risk as investments.

• Ms. Whitney expects a double dip recession - a W shaped, as I have called for as well.

The critics are already all over her and the market barely moved after her comments. Even supportive critics seem to willfully ignore the obvious going on around them. I have three close family members out of work and two three with reduced hours. My Saab buying neighbor just bought is daughter a Kia. My annual holiday trip to New York is going to be in a borrowed apartment, not a hotel. My credit lines have been pulled - fortunately I do not use them - and I had trouble getting a car lease because the lines have been pulled, reducing my credit score, even though I have never missed a bill payment in thirty two years of holding credit cards. A former neighbor - a real estate broker - who built a new home around the corner on one of the most desirable neighborhoods outside of Washington DC just rented her unsold, prior home for several years - a vote on her view of the market. And so on.

I am not unbiased -- my subscribers made unspeakable amounts of money in 2007 and 2008, first on the home builders and banks, then on the banks and the market, and the irrationality of the current market has cost them since I stick with fundamentals. And it took me too long to realize the government and the Fed would do whatever it takes -- fake stress tests, eliminate mark to market accounting rules, change regulatory treatment of commercial real estate loans and so on - to keep the big banks from failing as there was no more money to be had from Congress. Use this as a basis for going forward -- the big banks will not fail but the government is out of money, including the willingness of the Fed to stretch its balance sheet barring a major financial meltdown.

Back to Ms. Whitney - I hate when people call her Meredith as if they were friends, the same way they called Michael Jordan "Michael" as if he were a next door neighbor - listen to her even if the market is not - right now. The market rallied in July based on her comments - even then she said only the second half of 2009 would be good for the banks not 2010, and unemployment would hit at least 13% but no one listened. They need to listen now. Bottom line: traders need quicker trigger fingers if they are long and cash needs to be ready to short the money center banks most exposed to the consumer - BAC, WFC, and C - and over time the market in general.

Posted by Michael Shulman on November 17, 2009 10:39 AM | Permalink | Comments

Shorting The Blood Supply - Go Long Cerus (CERS)

Too bad blood banks are not publicly held, they, on and off, would be great shorts. Today an article in the Wall Street Journal highlighted the ongoing difficulties a critical supplier, the American Red Cross, was having keeping the FDA happy. (http://online.wsj.com/article/SB125807531639846383.html.) A couple of days ago the same publication published a piece on how swine flu was inhibiting people from donating or eliminating them from the population of potential donors. You would think in the twenty first century technology could solve the problem of donor contaminated blood.

It can -- and it is in Europe - not in the United States, just yet. The technology is found in the INTERCEPT system invented and marketed by Cerus (CERS). Simply put, INTERCEPT systems clean blood for eventual use as blood platelets, eliminating virtually all known pathogens - including HIV and swine flu. INTERCEPT systems make the collection (and tracking) of blood platelets nearly donor independent. Each collection of donor blood requires a disposable product used by the INTERCEPT system, so the company has a razor and blade business model with sales and margins expanding in an almost geometric pattern once a system is installed at a blood facility.

The product is approved in many European countries, is being deployed in earnest in France and on the verge of deployment in Germany. And typically the regulators there are tougher, on blood, than regulators here.

Cerus put together what they thought was a successful Phase III trial for INTERCEPT in the US a few years back, hit their primary endpoint and, statistically, their endpoints for safety as well. A subset of patients had a pulmonary problem on a very short term basis that did not push them past their final safety objective. No matter - some weenie at the FDA, and I am one of the few big fans of that overworked and under-resourced agency - said no good and the company turned its back on the US and focused on Europe.

On Monday, Cerus is back before the FDA presenting a Phase III trial design that looks pretty good to me. The panel will meet Monday and Tuesday and say yes or no. I believe they will get a green light to begin the trial, and given the success of the product in Europe, it is hard to imagine they will fail again in the US. What about another weenie at the FDA? Not this time - the current commissioner, Margaret Hamburg, is a former Commissioner of Health of the City of New York and has great expertise in pandemic preparedness. It is hard to believe she would let this one get away from her agency again - assuming they have told her about the panel meeting. This is, after all, Washington.

Approval of the trial design and, over time, a successful trial are major catalysts for the stock. But the company should become cashflow positive - real cashflow, not accounting cashflow - late next year without any help from US sales and has a bright future in Europe alone.

There are other positive wild cards for the company and the stock - things that could happen, which, as citizens, we do not want to happen. If swine flu or another pathogen gets in the blood supply, the FDA could exercise the powers they just used to give emergency approval for Peramivir (a treatment for flu) from Biocryst (BCRX) and do the same for INTERCEPT. Emergency approval is that, before final data and staff approval are in. Cerus management is not currently pursuing this - God knows why. Or, management could wake up and ask the Department of Homeland Security for funding for facilities or the trials - something Homeland Security is doing for Biocryst. Ditto on the God knows why comment. Both of these are real if remote possibilities dependent on a national emergency with the blood supply similar to the HIV tragedies of the 1980s.

Another wild card is the Pentagon - they have, in the past, let several contracts to Cerus for research but are barred from using INTERCEPT - remember, it is not approved by the FDA. They collect blood in the field that is not treated with pathogen inactivation technology. You think one or two of our soldiers might have an infectious disease, such as HIV, the soldiers unaware of the problem, soldiers giving blood that is not treated? Can you imagine the headlines if a pregnant Iraqi woman gets tainted blood and mother and child contract HIV from American supplied blood?

A last positive wild card is finding a marketing partner in the US if they get approval for INTERCEPT by the FDA. This makes sense - we are a big country with a fragmented blood industry - and a partnership with a major player would be a big deal for the company and the stock.

Yes, all wishful thinking but isn't that what you are supposed to do with emerging companies set to dominate their market? And they will - once an INTERCEPT system is in place, there is essentially a moat around that blood supplier and only a new, radically better technology - something no other company has or seems to be working on - could break through. Cerus has a multi year lead over competitors and once in place will stay in place, reinforcing their razor and blade business model.
Back to the present - Cerus is also working on early trials to modify its technology to treat whole blood, a huge market.

Oh, how big is the current Cerus? About $4.8MM in sales in Q3, probably $25-$27mm in sales next year, losing money but probably have positive cashflow by yearend 2010.
So, a very short term catalyst is near - next week's panel to approve or disapprove their trial design. Over time, and independent of US approval, quarterly sales and earnings are fundamental catalysts that will drive the stock. And any contamination of the blood supply, here or elsewhere, something I see as bound to happen, somewhere, sometime.

For purposes of disclosure, I am quite long Cerus.

Posted by Michael Shulman on November 13, 2009 9:50 AM | Permalink | Comments

Cancel Your Reservation to Open Table

Valuation alone is never a reason to short a stock - not even when it is 487 times current earnings. Slowing growth can be a reason for shorting a stock - a momentum stock - that goes from a 100% to a 20% growth rate in less than two years. A secondary offering that sells no company shares but insider and private investors shares - is that a warning sign? Or how about a company touting international sales - that equal one million dollars (that is million with an M, not billion with a B)?

The company in question is Open Table, a terrific service, a slowing company, a completely ridiculous stock.

Let me begin by saying I and my wife love the service, use it all the time, has simplified going out in our home town and when we travel. No knock on the service - in fact, the efficacy of the service has made OPEN something of a cult stock.
Where can I start? With management and early investors that cashed out through a secondary offering - generating roughly $200 million from investors, for previous investors, not the company. Smart move in a rough economy eh? Not to mention how much it shows current investors and management have in the stock price.

How about the end of the lock up agreement from the IPO in May - May 21 - in a few days. Think anybody who owns the stock at $20 might want to bag a 40% profit in light of all the private investors and senior managers who sold through the secondary offering? Including Benchmark Capital, which owns (or owned) 3.3 million shares, you think they might want to distribute the stock to investors/LPs (a rumor) and book the profit on paper before the stock crashes?

Or let's look at growth potential - true, excellent growth, 20% per annum - down from something like 100% - and at this rate, assuming profits climb half again as fast, the company will only need to grow 20% a year for 10 years to trade at the current market multiple.

I usually prepare longer analyses - and could do so here, tearing apart all their statements and whatever but there is no point. A wonderful service - but with management and early investors cashing out, a lock up ending on November 21 and a valuation multiple greater than that ever held by Microsoft in its great growth years, well, it is time to start thinking about shorting the stock. A fair price based on growth above the economy and the current market multiple is between $.50 and $5.00. As I write this the stock is trading at $27 and change.

Take a look, now - short interest is rising quickly but with the lock up expiring, a successful locate is going to much easier for those of you who take action.

Posted by Michael Shulman on November 12, 2009 8:45 AM | Permalink | Comments

How to Short the Coming Double Dip

The double dip has begun.

Statistically, we will see a rise in GDP in Q3 and in Q4. This is anticipated and meaningless data, but the numbers will hit headlines.

In the real world, the double dip has begun. Here is why - no one seems to be willing to pull things together in one short argument, perhaps for fear of being bored by a bull wearing green shoots. Simply put, all the core factors in driving an economy upward are broken other than pundit comments talking about "it must turn upward base on historical data." My historical note - we exited the Depression due to Hitler and Tojo, not a return to historical norms.

Unemployment: The reported unemployment number is 9.8%; real unemployment is 20% if you include those who have stopped looking and part time workers wanting to work full time. And the labor force participation rate is at a 23 year low.

National Income: Wages are falling and work hours are stagnant, according to this morning's jobs report, and combine these data with a shrinking work force and rising unemployment and you continue to have a sharp downturn in national income.

Consumer Spending: National income drives consumer spending, which is contracting due not just due to falling national income but rapidly contracting credit lines and a near 40% loss of accumulated wealth in the property and equity markets. And while consumer spending ostensibly is 70% of the economy, this includes spending on health care - love those government statisticians - so contraction has an incredibly outsized impact on consumer discretionary spending - luxury goods, travel, restaurants, unnecessary goods, expensive goods - anything you can trade down from to a lower level of price with equivalent functionality.

Credit Contraction: The credit contraction has been ferocious for consumers and small businesses as noted this morning by uber analyst Meredith Whitney (one of my favorites) in the Wall Street Journal. Depending on how you slice data, almost all increases in consumer spending since either 2002-2003 or 1997 has been due to credit. Trillions have been withdrawn and Ms. Whitney postulates another $1.5 trillion dollars will disappear in the coming months due to banking caution and changes in regulations. Given the total lack of credit to small business, and this segment is 38% of GDP and 50% of new job creation, there cannot be a recovery until credit begins to flow.

Zombie Banks: Nothing has changed with toxic assets and zombie banks - nothing, and even the IMF said this - and another $1.5 trillion needs to be written down, at least. Just because these assets are not in the headlines, and the Fed, the Treasury and the FASB faked stress tests and changed accounting rules, this does not mean the banks are or will be lending in a meaningful way in the near future. The Fed prints money, the banks sit on it to shore up busted balance sheets.
Business Investment: There are too many factories around the world, too many shopping malls an stores, too much commercial real estate - and at levels beyond all historical norms or comparisons. The first several legs of a rebound needed to absorb this capacity before we see any uptick in business investment that materially helps the economy.

The End of Stimulus: The buy gold and build a bomb shelter types have been screaming about the Fed printing money - what the Fed did was print enough money (they added a trillion to their balance sheet) to replace what was lost in the shadow and real banking systems - but not enough to replace what will be lost in the next 12-24 months. That being said, there is no political support for more stimulus. Deficits and a Congressional election preclude another stimulus package next year and the Fed and Uncle Sam have already said they are definitely pulling back, beginning November 1. We saw what happened to auto sales after Cash for Clunkers ended; ditto for home sales data in the coming weeks as the $8K tax credit expires. The bottom line: the economy will be much on its own next year.
Corporate Earnings: Corporate earnings follow the economy and they may be all right for Q3 and perhaps Q4 but they are going to disappoint the Street in 2010, big time. You can only cut costs so much - you need some top line growth - and it is only going to be there next year.

Markets: And one historical norm I like is the regressing of markets to the mean of corporate earnings. Translation - the market should be coming down next year or perhaps in 2011.

What to Do: If you like to short, consider the following - short the S+P (puts on the SPY), long term; short consumer discretionary spending via puts on the XLY; short the companies making stuff know one needs, like Harley Davidson (HOG) and Brunswick (BC); short companies making things no one can get credit to buy, such as new homes, via puts on the XHB ETF; short business spending via travel companies, the first thing to be cut in a business cutback, via puts on Avis (CAR); short retailers with terrible balance sheets, notably Macys (M).

Posted by Michael Shulman on October 2, 2009 10:02 AM | Permalink | Comments