Saturday, February 28, 2009

Berkshire Hathaway's Annual Shareholder Letter

Berkshire Hathaway's annual shareholder letter (PDF) was released today. Berkshire's decline in book value in 2008 was less than I would have expected, 9.6%. Below are a few brief excerpts.

Buffett On Some of his Mistakes in 2008:

I told you in an earlier part of this report that last year I made a major mistake of commission (and maybe more; this one sticks out). Without urging from Charlie or anyone else, I bought a large amount of ConocoPhillips stock when oil and gas prices were near their peak. I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year. I still believe the odds are good that oil sells far higher in the future than the current $40-$50 price. But so far I have been dead wrong. Even if prices should rise, moreover, the terrible timing of my purchase has cost Berkshire several billion dollars.

I made some other already-recognizable errors as well. They were smaller, but unfortunately not that small. During 2008, I spent $244 million for shares of two Irish banks that appeared cheap to me. At yearend we wrote these holdings down to market: $27 million, for an 89% loss. Since then, the two stocks have declined even further. The tennis crowd would call my mistakes “unforced errors.”

On Why Berkshire Sold Some of its Stakes in JNJ, PG, and COP:

On the plus side last year, we made purchases totaling $14.5 billion in fixed-income securities issued by Wrigley, Goldman Sachs and General Electric. We very much like these commitments, which carry high current yields that, in themselves, make the investments more than satisfactory. But in each of these three
purchases, we also acquired a substantial equity participation as a bonus. To fund these large purchases, I had to sell portions of some holdings that I would have preferred to keep (primarily Johnson & Johnson, Procter & Gamble and ConocoPhillips). However, I have pledged – to you, the rating agencies and myself – to always run Berkshire with more than ample cash. We never want to count on the kindness of strangers in order to meet tomorrow’s obligations.

On Treasury Securities:

When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary.

On the limits of Regulation:

For a case study on regulatory effectiveness, let’s look harder at the Freddie and Fannie example. These giant institutions were created by Congress, which retained control over them, dictating what they could and could not do. To aid its oversight, Congress created OFHEO in 1992, admonishing it to make sure the two behemoths were behaving themselves. With that move, Fannie and Freddie became the most intensely-regulated companies of which I am aware, as measured by manpower assigned to the task.

On June 15, 2003, OFHEO (whose annual reports are available on the Internet) sent its 2002 report to Congress – specifically to its four bosses in the Senate and House, among them none other than Messrs. Sarbanes and Oxley. The report’s 127 pages included a self-congratulatory cover-line: “Celebrating 10 Years of Excellence.” The transmittal letter and report were delivered nine days after the CEO and CFO of Freddie had resigned in disgrace and the COO had been fired. No mention of their departures was made in the letter, even while the report concluded, as it always did, that “Both Enterprises were financially sound and well managed.”

In truth, both enterprises had engaged in massive accounting shenanigans for some time. Finally, in 2006, OFHEO issued a 340-page scathing chronicle of the sins of Fannie that, more or less, blamed the fiasco on every party but – you guessed it – Congress and OFHEO.

"Buy and Hope Investing"

The two graphics above come from John Mauldin's latest weekly newsletter, "Buy and Hope Investing". In it, Mauldin takes Wharton Professor Jeremy Siegel (author of the buy & hold tome Stocks for the Long Run) to task for Siegel's op/ed column in this week's Wall Street Journal ("The S&P Gets Its Earnings Wrong: Stocks are cheaper than they look."). Mauldin also adds some comments about President Obama's budget proposal and some bullish comments about what the longer-term holds. Below are a few excerpts on each of those topics.

On Jeremy Siegel:

Let's be clear. I like Jeremy Siegel. He is a very nice and very smart gentleman. But in his op-ed piece, I think he was talking his book, if you can pardon the pun.


[L]et me state unequivocally that there are stocks in the S&P 500 that are good values. If you buy them today you will be rewarded in the medium and long run. Don't ask me which ones, because I don't do stocks -- I have enough on my plate looking at investment managers and the economy. But there are value managers who will do well from this point. The fact that they have been hammered by 50% or more in the past year is another story for another letter. (But nearly all of them made the case that "today" was a good time to buy their fund and did so every day for the last year.)


Stocks that lose money fall in price. That is no mystery. And if you are an index investor, you want to know what the index is going to do, not what just some of the stocks are going to do. If the market cap of Citibank drops by 90%, it is going to affect the index. In Jeremy's system, the positive earnings of Citibank in 2006 would be weighted 10 times more than the losses in 2008. That does not help you assess overall index value going forward.


Who might want to use such a different weighting methodology? Someone who was committed to buy and hold, has seen their portfolio trashed, and wants to hold on to some hope that their stock is going to come back. Such statistics are a kind of feel-good narcotic for the buy and hope crowd.

For the last 18 months there has been a parade of analysts, mutual fund managers, brokers, and their kin, telling you that stocks are a reasonable value "today." And they trot out "data" (with lots of charts) which supports their position and then ask you to invest "now."

"The stock market turns up six months before the end of the recession. This recession is already almost the longest, so now is the time to buy." The bullish cheerleaders said that six months ago, they say it today, and they will say it in six months. One day they will be right. Care to make a bet?

On President Obama's Budget Proposal:

This week saw President Obama give us a budget with a projected deficit of $1.75 trillion dollars, and a massive tax increase on the "wealthy." But hidden in the details was an even larger tax increase on everyone. Obama wants to create a cap-and-trade program for carbon emissions. This is expected to generate $79 billion in 2012, $237 billion by 2014, and grow to $646 billion by 2019. These will be payments by energy (primarily utility) companies to the government. That will cause utilities to have to raise the prices they charge customers for energy. Such a level of taxation is eventually 4-5% of total US GDP. That is not small potatoes. And since the wealthy do not use all that much more power than the rest of us, it will affect the lower incomes disproportionately.

It will take money out of consumers' pockets and transfer it to the government. You can call it cap-and-trade, but it is a tax. And a huge one. Anything that will take 4% of GDP away from consumer spending is not business friendly. And by driving the cost of energy up, it will drive high-energy-using businesses away from the US to developing countries where energy is cheaper1. It will make it even harder for people to save money and drive up costs for the elderly and retired. But it will make the environmental lobby happy.


Just as a fragile economy is ready to pick itself back up, a large series of tax increases will help slow it down and may push us back into recession.

Which brings me back to my earlier point. Buying a stock market index in today's environment is as much a matter of hope as it is anything else. I readily admit you can make a case for individual stocks, but a large index is a reflection of the broad economy, whether in the US or Japan or Europe. The global economy is weak and likely to be so for some time.

On The Longer-Term (a little sugar to wash down that medicine):

[L]et me also suggest that when we do get the problems worked out, and we will, the recovery that ensues may be breathtaking in its scope, as the technological changes that will be coming down the pike in the next 5-10 years are simply going to dwarf what we have seen in the past 30. Ray Kurzweil2 predicts that we will see twice as much change in the next 20 years as we saw all of last century. Think about the implications of that.

1We made a similar point in a post last fall ("A Tale of Two States: Utah Versus Rhode Island"), noting that one reason Utah's unemployment rate was so much lower than Rhode Island's was because Utah's industrial electricity costs were roughly a third of Rhode Island's.

2We mentioned Kurzweil in a couple of recent posts (e.g., "Singularity U."). See also J.K.'s comments on that post.

Thursday, February 26, 2009

"Jindal's Missed Opportunity"

Smart piece by Nicole Gelinas of the Manhattan Institute in its magazine City Journal: "Jindal's Missed Opportunity" (Hat Tip: Real Clear Politics). Excerpts:

Jindal noted that Republicans have an “honest and fundamental disagreement” with Democrats about “the proper role of government.” Regarding the public sector’s ability to rescue Americans from the economic storm, he said, “those of us who lived through Hurricane Katrina—we have our doubts.” Jindal told how, in the immediate aftermath of the 2005 storm, he went to visit Sheriff Harry Lee (now deceased) and found him yelling into the phones. Lee had learned that volunteers in boats were ready to go out and help, but that “some bureaucrat” had told them they couldn’t do so without insurance and registration. The sheriff told the boaters to “ignore the bureaucrats and go start rescuing people.” From this tale, Jindal concluded, America should realize that “the strength of America is not found in our government” but in the “enterprising spirit” of regular people.

The problem with Jindal’s story—and one reason why Republicans are in so much trouble now—is that reasonable people don’t consider providing critical, life-saving support for starving and dehydrated people after an unprecedented natural disaster to be an example of scarily big government. That’s just minimally competent government, even in a country far less developed than ours. In fact, Jindal’s story illustrates the opposite of what he intended. Lee, a longtime government1 official, personified the functional, nimble government that we need. He overrode unnamed bureaucrats and told volunteers that he’d be personally responsible if they ran into any more trouble. Lee made a smart decision on the fly and saved lives. Unfortunately, other officials—at all levels, with only a few exceptions—proved shamefully negligent in their responses. Because they failed at their jobs, people died.


Americans don’t see abject government incompetence as an argument for no government. They see it as an argument for a government that is at least passably competent at fundamental tasks. Republicans do the country a disservice by not recognizing this truth. And since some Democrats seem to confuse Americans’ desire for a competent government with a desire for a government that does everything—a disastrous misstep in the opposite direction—Republicans need to provide a rational counterweight.

The banner image above comes from the City Journal website.

1To be fair to Jindal, it seemed clear from the context (a response to a POTUS speech) that by "government" he was implicitly referring to the federal government. There are some things only the Federal government can do, but it's not unreasonable for a conservative (or anyone else, for that matter) to prefer to have more responsibility and resources devolved to the state and local levels (e.g., to men like Sheriff Lee).

Wednesday, February 25, 2009

PhotoChannel Turns a Profit

From the company's press release ("PhotoChannel Reports Profitable First Quarter"):


- Net profit of $940,644 versus a loss of $1,082,600 for
the comparable period of fiscal 2008

- Record revenues of $7.2 million, up 67% year-over-year

- Transactional revenues of $5.8 million, up 91% year-over-year

- Non-GAAP adjusted EBITDA(1) of $2.8 million, compared
to an adjusted EBITDA loss of $117,483 in the first quarter
of 2008 (adjusted EBITDA defined as net profit plus amortization
and stock-based compensation expense)

- Non-GAAP adjusted EBITDA representing 39% of net-revenues
for the quarter

- Earnings per share (EPS) of $0.03 versus a loss per share
of $0.03 for the comparable period of fiscal 2008

- Non-GAAP adjusted Earnings per share (EPS)(1) of $0.08
versus $0.00 for the comparable period of fiscal 2008

- At December 31, 2008 the Company had approximately $3.1
million cash on its balance sheet


- Over 4.9 million orders were transacted in the first quarter
of fiscal 2009

- Average daily orders of approximately 53,000 versus 15,000
for the same period of fiscal 2008, a 240% increase year-over-year

- Peak day saw over 134,000 orders placed and over 5.2 million
images pass through the PNI Platform

Comparing Bear Market Declines

Hat tip to Andrew Sullivan for this chart.

The Wrong Way to Counter Negative Stereotypes about Muslims

This news item is a week old, apparently, but I just learned of it from the Real Clear Politics blog. The fellow in the photo above is Muzzammil Hassan. According to CNN,

He launched Bridges TV, billed as the first English-language cable channel targeting Muslims inside the United States, in 2004. At the time, Hassan said he hoped the network would balance negative portrayals of Muslims following the attacks of September 11, 2001.

Last week Mr. Hassan was charged with torturing and beheading his wife, Aasiya Hassan (the woman on the right in the photo above), who had filed for a divorce earlier this month.

The photo above, of Mr. Hassan and his late wife, comes from the CNN article.

Ross Douthat on Obama's Speech and Jindal's Response

From his Atlantic blog ("Snap Judgments"):

Obama was fantastic - worlds better than his inaugural. He laid out the most ambitious and expensive domestic agenda of any Democratic President since LBJ, and did it so smoothly that you'd think he was just selling an incremental center-left pragmatism. I think that he has an acute sense - more acute than most people in Washington, probably - of just how much running room is open in front of him at the moment, and he intends to make the absolute most of it. Burkean temperament or no, this was not a Burkean speech by any stretch: It was the speech of a man seeking to turn a moment of crisis into a domestic-policy revolution, and oozing confidence from every pore along the way. Now all he has to do is find a way to pay for it ...
And Jindal - yeah, he was just as lousy as everybody's saying. As far as themes and messaging went, he basically chose option A on Ambinder's list - government isn't the solution; pork is the problem; etc. - and embedded it in a weak, sing-song delivery that I suspect left even the people who respond favorably to that message cold. Sure, responding to a Presidential speech is almost always a thankless, hopeless job - but shouldn't someone as smart as Jindal have recognized that, and either turned the opportunity down flat, or found a way to sound like something other than a kindergarten teacher delivering familiar GOP talking points? In the event, his speech was the capstone on a lousy night for conservatism: If that's the best the Right has to offer as a rebuttal to Obama, American liberalism is going to be running untouched down the field for years to come.

Douthat's mostly on-target here. There are plenty of legitimate criticisms of the stimulus bill Obama recently signed -- e.g., that it won't provide enough stimulus when it's needed most, that many of its provisions aren't likely to be temporary and will strain the long term fiscal picture, etc. -- but dogmatically opposing fiscal stimulus during a long recession (especially when monetary policy has already taken the Fed funds rate to near-zero) is bad politics and bad economics. The smarter approach for Republicans in Congress would have been to demand a more effective stimulus -- one with more temporary, fast-acting measures (e.g., more aid for the unemployed, a payroll tax holiday, a temporary tax credit to encourage businesses to move up capital spending to this year, etc.).

On the other hand, on the longer-term policy objectives President Obama listed in his speech last night (e.g., free college for everyone, etc.), a good economic case (though a more difficult political one) can be made to oppose them, or to offer more fiscally sustainable alternatives.

Governor Jindal is a Rhodes Scholar who has had a meteoric political career so far, so he ought to be smart enough to realize this. He has time to reposition himself as a "effective government" conservative and differentiate himself from some of the Republican leaders in Congress by offering intelligent, nuanced opposition to President Obama's liberal policies. Jindal's rebuttal last night was an inauspicious start though1.

1One small example was Jindal's mockery of volcano monitoring in his rebuttal last night. As Matt Yglesias asked on his blog,

What’s with the attack on “something called ‘volcano monitoring’”? Volcano monitoring is where they monitor volcanos. So as to better understand, better predict, and better prepare for natural disasters. Is that so complicated? Are only hurricanes worth responding to?

If you're going to pick an example of wasteful government spending, volcano monitoring doesn't seem like the best one (not that Sen. McCain got much traction last fall with his jihad against pork -- which, in the big picture, has little impact on the federal budget anyway).

Monday, February 23, 2009

Paul Volcker Laments

In the previous post ("Saving Capitalist Banking from Itself") we excerpted part of the first item John Mauldin1 included in his "Outside the Box" e-mail today. The second item Mauldin included in today's e-mail was the text of a speech Paul Volcker recently gave in Toronto. The main subject of the speech was the sort of financial system Volcker envisions we'll have when the dust eventually settles. The speech isn't very long and is worth reading in full on Mauldin's site, but excerpted below is a brief passage that jumped out at me as I was reading it:

One of the saddest days of my life was when my grandson – and he's a particularly brilliant grandson – went to college. He was good at mathematics. And after he had been at college for a year or two I asked him what he wanted to do when he grew up. He said, "I want to be a financial engineer." My heart sank. Why was he going to waste his life on this profession?

A year or so ago, my daughter had seen something in the paper, some disparaging remarks I had made about financial engineering. She sent it to my grandson, who normally didn't communicate with me very much. He sent me an email, "Grandpa, don't blame it on us! We were just following the orders we were getting from our bosses." The only thing I could do was send him back an email, "I will not accept the Nuremberg excuse."

"Saving Capitalist Banking from Itself"

In addition to his weekly newsletter, John Mauldin1 occasionally e-mails articles written by others as part of his "Outside the Box" series. Today's "Outside the Box" e-mail included a couple of good ones (both of which can be read in full here). To keep this post from getting too long, I'll post an excerpt from the second one in a separate post. The graphic above comes from the first, "Saving Capitalist Banking from Itself", by PIMCO Managing Director Paul McCulley2. McCulley starts with a recap of the basics of fractional reserve banking and continues with a description of the shadow banking system. The excerpt below is from the "bottom line" part of his essay:

The United States government now has both the tools and the will to save the private banking system, and more importantly, the real economy, from its own debt-deflationary pathologies. Not that it will be easy. But it can be done, notwithstanding the catcalls that greeted Secretary Geithner last week.

And the essential game plan is clear: use the power of the Fed, the FDIC and the Treasury to create government-sponsored shadow banks, such as the Term Asset-Backed Securities Lending Facility (the TALF) and the Public-Private Investment Fund (the P-PIF).

The formula? Take a small dollop of the Treasury's free-to-spend taxpayer money (there is still $350 billion left) to serve as the equity in a government sponsored shadow bank, and then lever the daylights out of it with loans from the Federal Reserve, funded with the printing press. That's the formula for the TALF, to provide leverage, with no recourse after a haircut, to restart the securitization markets.

The same formula applies for the P-PIF, with the addition of FDIC stop out loss protection for dodgy bank assets that private sector players might buy. With such goodies, such players, it is hoped, will be able to pay a sufficiently high price for those assets to avoid bankrupting the seller bank.

Unfortunately, Secretary Geithner hasn't laid out the precise parameters of how to mix these three ingredients, which is driving the markets up the wall. But make no mistake, these are the ingredients, along with continued direct capital infusions into banks where necessary.

2You may recall McCulley's name from a previous post where we excerpted one of his essays, "Breaking the Paradox of Deleveraging".

Hussman Pivots

In his latest weekly commentary ("The Economy Needs Coordination, Not Money, From the Government"), Dr. Hussman seems to pivot a little on a couple of positions he took in his last market commentary (from which we excerpted in this post, John Hussman on "How to Climb out of a Global Financial Hole"). Last week, Hussman wrote this about Citigroup and some other large banks,

The government should continue to provide capital directly to large, diversified financial institutions which remain solvent but have some impairment to capital. Preferred stock is a reasonable form, though a high (possibly deferred) yield to the government is preferable to a low one (Bagehot's Rule[1]). Tight restrictions against using taxpayer capital for compensation and bonuses are certainly appropriate. These institutions include major banks like Citigroup, Bank of America, Wells Fargo, J.P. Morgan, and others, which appear to be experiencing pressure not because of insolvency, but because of uncertainty about potential future loan losses, and the ongoing availability of publicly provided capital.

Market action over the last week seems to have prompted a different view of Citi from Hussman today,

Take a look at Citibank's balance sheet as of the third quarter of 2008. The company had about $2 trillion in assets, versus about $132 billion in shareholder equity, for a gross leverage ratio of about 16-to-1. That's not a comfortable figure, because it indicates that a decline of about 6% in those assets would wipe out Citibank's equity and make the bank technically insolvent. Unfortunately, we saw credit default spreads screaming higher last week, while the bank's stock dropped below $2 a share, so evidently the market is deeply concerned about the possible immediacy of that outcome.

Instead of the government providing additional capital to Citi, now Hussman favors a sort of receivership,

But keep looking at the liability side of Citibank's balance sheet. There is over $360 billion in long-term debt to the company's bondholders, and another $200 billion in shorter term borrowings. None of that is customer money. That puts the total capital available to absorb losses at $132 + $360 + $200 = $692 billion, which is about 35% of the $2 trillion in assets carried by Citibank. That's a huge cushion for customers, who are unlikely to lose even if Citibank becomes insolvent. Should that occur, the proper response of government will not be to defend Citi's bondholders at taxpayer expense, but rather, to take Citi into receivership, wipe out the shareholders and most of the bondholders, and sell the assets along with the liabilities to customers to another institution.

On the broader point of dealing with foreclosures, Hussman still highlights the need for government coordination and the creation of PARs (proper appreciation rights) to compensate lenders for writing down the principal amounts of mortgages, but takes a slightly different tack on the issue of mortgage "cram-downs". Last week, Hussman wrote,

The most direct method of intervening is at the point of foreclosure through the courts. One way of doing this would be to give judges the ability to write down principal, and to assign the balance as a deferred “property appreciation right” (PAR) to the lender.

And this week, Hussman writes,

If you simply let bankruptcy judges push down principal values with no other recourse to lenders, you undermine the basic principles of contract law that underpin our economy. If you provide government funds to reduce the mortgage principal of some homeowners, with nothing for those who have played by the rules, you create huge inequities and incentives for good homeowners to go delinquent.

It may be that Hussman is being consistent here, i.e., that he's OK with allowing judges to reduce the principal on mortgages provided they compensate lenders with a PAR equivalent to amount the principle was reduced. Perhaps Dr. Hussman will clarify this next week. I suspect, though, that if the government facilitated a market for PARs (as Hussman recommends), most lenders would write down their mortgages in return for PARs voluntarily.

The chart above, which was included in Hussman's column, illustrates a point Hussman made about the steep recent decline in S&P earnings (earnings have historically grown 6% from one cyclical peak to the next cyclical peak).

Sunday, February 22, 2009

More on Moyo

In a post last month ("An African Economist on Western Aid to Africa"), we mentioned the Zambian-born economist and author Dambisa Moyo, and posted an excerpt from the interview with her in the Financial Times. Today's New York Times Magazine features an interview with Moyo as well ("Questions for Dambisa Moyo -- The Anti-Bono"). From the interview:

Q: As a native of Zambia with advanced degrees in public policy and economics from Harvard and Oxford, you are about to publish an attack on Western aid to Africa and its recent glamorization by celebrities. ‘‘Dead Aid,’’ as your book is called, is particularly hard on rock stars. Have you met Bono?
I have, yes, at the World Economic Forum in Davos, Switzerland, last year. It was at a party to raise money for Africans, and there were no Africans in the room, except for me.


You argue in your book that Western aid to Africa has not only perpetuated poverty but also worsened it, and you are perhaps the first African to request in book form that all development aid be halted within five years.
Think about it this way — China has 1.3 billion people, only 300 million of whom live like us, if you will, with Western living standards. There are a billion Chinese who are living in substandard conditions. Do you know anybody who feels sorry for China? Nobody.

Maybe that’s because they have so much money that we here in the U.S. are begging the Chinese for loans.
Forty years ago, China was poorer than many African countries. Yes, they have money today, but where did that money come from? They built that, they worked very hard to create a situation where they are not dependent on aid.

The photo above, of Ms. Mayo, accompanied Deborah Solomon's interview.

Pabrai's New Buys

In a recent post ("Mohnish, How Are You Feeling?"), we linked to Mohnish Pabrai's annual investor letter in which he wrote that he had invested in a number of businesses in the commodities sector in 4Q08. On Seeking Alpha, Davy Bui lists Pabrai's new positions (Hat Tip: The Guru Five):

Pabrai's new positions can be summed up as a bunch of commodities with a hint of financials. New mining stakes include Horsehead Holding Corp (ZINC), Teck Cominco (TCK) and indirectly, Leucadia National (LUK). He also moved into the agriculture space with Potash (POT) and Cresud SA (CRESY). He also added a good-sized position in Goldman Sachs (GS), which received a well-publicized capital boost from Pabrai's acknowledged idol, Warren Buffett. Pabrai completely divested his WCG position and massively reduced stakes in Buffett's Berkshire, Cryptologic (CRYP), CompuCredit (CCRT) and Fairfax Financial (FFH).

"Dutchman who turned Nazi Debris into a dialysis machine"

From this weekend's Financial Times obituary for Willem 'Pim' Kolff, written by Phil Davison ("Dutchman who turned Nazi debris into a dialysis machine"):

There were parts from a downed Luftwaffe fighter aircraft and from the radiator of an abandoned Ford car. There were orange juice tins, an enamel bathtub, a wooden drum and thin, artificial sausage skins.

The strange prototype would one day save the lives of millions. Kolff himself, an inventive genius who has died at the age of 97, would go on to become the driving force behind the first artificial heart as well as a man-made eye, an artificial ear and one of the first sophisticated prosthetic arms. He never patented any of his inventions because he believed they should benefit all mankind, not one individual.

His early dialysis machines failed and 16 patients died. The 17th, just weeks after the end of the second world war in 1945, was 67-year-old Sophia Schafstadt, a Nazi collaborator.

“Most people wanted to wring her neck,” said Kolff later. He himself had supported the Dutch resistance. He had helped save 800 of his countrymen from Nazi labour camps by hiding them – he concealed one 10-year-old Jewish boy in his own home – or by helping them fake the symptoms of disease. Yet he still used his machine to bring Schafstadt, the dying Nazi sympathiser, out of a coma and she lived for another seven years.

“The moral is that we have to treat patients when they need help even if we don’t like them,” he said.


Kolff recalled later that her first words as she came out of the coma were: “I’m going to divorce my husband.” Her husband had opposed the Nazis – and she did divorce him.

The article also notes that Kolff led the team at the University of Utah that implanted the first artificial heart in a human (Barney Clark): Robert Jarvik, after whom that artificial heart was named, was one of Kolff's students. Jarvik, of course, is also the former star of Pfizer's Lipitor commercials.

Saturday, February 21, 2009

Late Scone Availability as a Bearish Indicator for Starbucks

I'm writing this from a local Starbucks, and it's quiet enough here that I overheard someone inquiring about a blueberry scone in the pastry case. Last year, the scones tended to sell out here (and at other local Starbucks stores) by early afternoon. There's also Top Pot1 apple fritter sitting in the case. That's another morning item that would typically sell out before the early afternoon.

The image above, of the blueberry scone, is from Flicr.

1The Top Pot locations in Seattle have great coffee and fresh donuts, by the way. Too bad there isn't a local chain like that here. I think it would do well.

"While Rome Burns"

John Mauldin's latest Thoughts from the Frontline newsletter, "While Rome Burns", includes the graphic above1, from BCA Research. The column consists mainly of two sorts of gloom. The second sort, about the negative prospects for buy-and-hold stock investing when earnings are dropping faster than stock prices, so P/E ratios are high despite the recent market action, is generic enough that I won't excerpt it here. The first bit of gloom concerns the banking situation in Europe. From the newsletter,

Austrian banks have lent $289 billion (230 billion euros) to Eastern Europe. That is 70% of Austrian GDP. Much of it is in Swiss francs they borrowed from Swiss banks. Even a 10% impairment (highly optimistic) would bankrupt the Austrian financial system, says the Austrian finance minister, Joseph Proll. In the US we speak of banks that are too big to be allowed to fail. But the reality is that we could nationalize them if we needed to do so. (And for the record, I favor nationalization and swift privatization. We cannot afford a repeat of Japan's zombie banks.)

The problem is that in Europe there are many banks that are simply too big to save. The size of the banks in terms of the GDP of the country in which they are domiciled is all out of proportion. For my American readers, it would be as if the bank bailout package were in excess of $14 trillion (give or take a few trillion). In essence, there are small countries which have very large banks (relatively speaking) that have gone outside their own borders to make loans and have done so at levels of leverage which are far in excess of the most leveraged US banks. The ability of the "host" countries to nationalize their banks is simply not there. They are going to have to have help from larger countries. But as we will see below, that help is problematical.

Western European banks have been very aggressive in lending to emerging market countries worldwide. Almost 75% of an estimated $4.9 trillion of loans outstanding are to countries that are in deep recessions. Plus, according to the IMF, they are 50% more leveraged than US banks.

1The low ranking here of Australia is surprising to me, considering that up until last year the country had no net federal debt. It looks like the Australian government will run fiscal deficits in the short-term, as it attempts to stimulate its economy, but how that is supposed to make its sovereign debt risk higher than that over already heavily-indebted countries, I don't know. Given what Mauldin has written about Austria above (with public debt equal to about 59% of GDP, according to the CIA World Fact Book), for example, I'm surprised that Austria is considered less of a sovereign credit risk than Australia by BCA.

Friday, February 20, 2009

An Atypical Perspective on Health Care in the NY Times

Last month, the New York Times Magazine published a sprawling cover article by David Leonhardt on how the Obama administration might "remake" the American economy ("The Big Fix"). One of Leonhardt's arguments was that the U.S. spends too much on health care, often without commensurate results, and in his article he suggested spending less on health care and more on education (this view seems to be gaining traction on the left). Despite the length of his article, Leonhardt didn't offer much by way of empirical data in support of his claim about the limited benefits of health care spending or the potential benefits of spending more on education (his argument in support of more emphasis on education included this observation, "The two most affluent immigrant groups in modern America — Asian-Americans and Jews — are also the most educated," without addressing any of the obvious questions that observation raises).

Last Sunday, the New York Times business section offered a different perspective on health care spending, from William Hawkins, the CEO of Medtronic ("The Boss: For Medtronic’s Chief, Success That Hits Home"). Excerpt:

Advances in technology enable us to do things today we weren’t able to do years ago, such as monitoring and managing patients remotely. Twenty years ago when we implanted a defibrillator, it cost $100,000 and wasn’t nearly capable of the performance of today’s devices that are a fraction of the cost.

My family has also been a driving force behind my journey. I have a photo in my office of three of my relatives. My father, 83, has eight coronary stents, some of them ours. My 91-year-old uncle, an injured World War II veteran, suffered from a tremor for years that made his hands shake. When he was 89, doctors implanted one of our deep brain stimulators, which controls movement. When they turned it on, for the first time in 40 or 50 years his hands stopped shaking and he got his life back. My father-in-law, who is 86, has a Medtronic heart valve, stents and a pacemaker.

One of the reasons I’m working is to make sure I can take care of my family so we can enjoy a long life together.

It sounds like Mr. Hawkins's relatives have gotten some positive results from their health care spending. Would we really be better off as a country if that money were thrown into the latest sisyphian federal program to improve public education instead?

The image above, of the deep brain stimulator, is from Wired.

Thursday, February 19, 2009

PhotoChannel Update

On Wednesday, PhotoChannel (OTC BB: PNWIF.OB) issued a somewhat Delphic press release ("PhotoChannel Announces the Launch of the PNI Open Access Project"). In it the company announced,

The PNI Open Access Project has been created for non-PNI customers to be able to take advantage of and utilize the power of the PNI Platform's "Routing Tier" that currently delivers millions of images and orders from PNI hosted websites to its customer's stores and production facilities.

There was nothing in the press release about revenue projections related to this project, or the reactions of PhotoChannel's current clients to it, so reader N.L. did some legwork on this and was kind enough to share what he found with us.

The first time N.L. contacted the company today, investor relations forwarded him a morning research note from Merriman Curhan Ford, which offered no specific insights into the Open Access Project (beyond some general speculation about the size of the potential market opportunity, e.g., the number of Facebook users), but did offer some general guidance on PhotoChannel. From the research note,

We expect strong December quarter results next week, where we are projecting revenue growth of 99% coupled with the company turning profitable with $0.05 in EPS, as well as a sequential more than doubling of EBITDA (going to $3.7M from $1.7M in 4Q08). In our opinion this will be the quarter that we (and everyone else) have been waiting for – the emergence of PhotoChannel into profitable territory. Not only did PhotoChannel generate same-store sales of approximately 40% in the December quarter, but the company is also now experience a solid revenue ramp with its newest retail partners, Costco USA and Sam’s Club.

·Reiterating Buy. In our opinion, PhotoChannel is poised to become a leading provider to the digital photofinishing market by offering a fully integrated solution to retailers — having already locked up most of the top photofinishing retailers in the U.S., Canada and the U.K. – with global digital print revenues estimated to eclipse $100B by 2010. We continue to believe using a 15-20x P/E multiple is conservative and achievable—yielding appreciation potential to the $4.25-5.50 range on our FY10 EPS estimate of $0.28.

Expecting a double-digit multiple on any stock in this secular bear market seems a tad too optimistic to me, but it would be encouraging to see PhotoChannel become profitable and continue growing revenues.

N.L. also checked Issambres839/Aaron Edelheit's comment on Value Investors Club, but Edelheit had no specific information either and instead offered similar speculation as the Merriman analyst. After contacting PhotoChannel directly again, N.L. got this vague response:

This is just an "opportunity" for PNI. The company will go into more detail on the Feb 25 conference call.

N.L. noted in an e-mail to me that the recent positive performance of PhotoChannel's stock has been in spite of the overall market weakness (e.g., closing up about 9% today; see the chart above).

Alloy Steel Update

Ugly tape for Alloy Steel International (OTC BB: AYSI.OB) on a down day. Looks like a flat-lining EKG. No company-specific news today, but there have been some tentatively positive indicators related to the metals sector recently1. Picked up a few more shares today at .29.


- Temasek, the $134 billion Singaporean sovereign wealth fund, recently hired Chip Goodyear, former CEO of blue chip miner BHP Billiton, as its new chief (Wall Street Journal: Temasek Shakes Up Its Top Ranks -- Ho Ching Out, 'Chip' Goodyear In at Singapore Fund; a Commodity Push?)

- China bought a stake in (over-levered) blue chip miner Rio Tinto (BBC: China takes a stake in Rio Tinto)

- The Baltic Dry Index was up 147% year-to-date as of February 17th (Bloomberg: "Shipping Index Surge Signals Commodity Currency Gains"). It's up about 166% as of today (but still down steeply from its 2008 highs).

On the other hand, the continuing global recession is obviously bearish, and as reader Sivaram noted in a recent comment thread ("Mohnish, How Are You Feeling"), Mohnish Pabrai mentioned in his annual investor letter that he has turned bullish on the commodity sector, which, given his recent track record, could be considered a bearish indicator.

Wednesday, February 18, 2009

Economics as Politics by Other Means

Although Greg Mankiw didn't mention it specifically in the post I linked to previously ("News Flash: Economists Agree"), I wonder if part of what prompted him to write it was the row set off by Clive Crook's Financial Times column last week, ("Politics is damaging the credibility of economics"). In that column Crook wrote,

Economics outside the academy has become the continuation of politics by other means. If you wish to know what Mr [Paul] Krugman thinks on any policy question, do not read his scholarly writings; see which policies are advocated by the progressive wing of the Democratic party. Mr Krugman agrees with liberal Democrats about most things, and for the rest gives as much cover as the discipline of economics can provide - which, given its scientific limitations, is plenty. He does this even on matters where, if his scholarly work is any guide, the economics is firmly against his allies. Liberal Democrats are protectionists. Mr Krugman is not, but politics comes first.

The syndrome affects economists on the right as much as on the left. Just as there is a consensus among economists that protectionism should be opposed, most economists believe that a powerful fiscal stimulus is both possible and desirable in present circumstances, and that the best stimulus would include big increases in public spending. Yet recently, Robert Barro, a scholar with conservative sympathies, wrote in the Wall Street Journal that this view was an appeal to "magic".

The problem is not that Mr Krugman questions the consensus on trade (if indeed he does), or that Mr Barro questions the consensus on fiscal policy (as he certainly does). It is that both set the consensus aside so carelessly. In doing so, these stars of the profession destroy the credibility of their own discipline. Mr Krugman gives liberals the economics they want. Mr Barro gives conservatives the same service. They narrow or deny the common ground. Why does this matter? Because the views of readers inclined to one side or the other are further polarised; and in the middle, those of no decided allegiance conclude that economics is bunk.

Crook threw in a (mostly accurate) criticism of the blogosphere as well:

The web, for all its blessings, is an aggravating factor. Many of the most successful economics blogs promote communication within political groupings, not across them. On the web you best build an audience by organising a claque and stroking its prejudices. Extend elaborate courtesy to people you agree with and boorish contempt to those who do not get it. Celebrate exasperation and incivility as marks of intellectual authenticity - an attitude easier to tolerate in teenagers under hormonal stress than in professors at world-class universities.

For Krugman's and Barro's respective responses to that column, see Crook's Atlantic blog post, "The Dismal Science, Revisited".

"News Flash: Economists Agree"

Hat tip to Atlantic blogger Andrew Sullivan for linking to this post by Greg Mankiw, the Harvard economist and former Bush Administration Chairman of the Council of Economic Advisers: "News Flash: Economists Agree". From Mankiw's post,

The recent debate over the stimulus bill has lead some observers to think that economists are hopelessly divided on issues of public policy1. That is true regarding business cycle theory and, specifically, the virtues or defects of Keynesian economics. But it is not true more broadly.

Mankiw goes on to list fourteen propositions on which a majority of economists agree, according to various polls of the profession. The fourth one is the most relevant to the recent stimulus debate:

Fiscal policy (e.g., tax cut and/or government expenditure increase) has a significant stimulative impact on a less than fully employed economy. (90%)

Mankiw adds,

Note that the proposition about fiscal policy (#4) does not distinguish between taxes and spending as the best tool for purposes of macro stabilization. Maybe that question should be added in a future poll. I doubt, however, that the answer would make it onto this list of widely agreed upon propositions.

A Local Business That Seems to be Doing Well

The NJ location of the Japanese Mitsuwa Marketplace (pictured above) features these specialty shops and restaurants, along with a Japanese supermarket. We stopped in last Saturday and picked up a six pack of Asahi beer, and then had lunch the next day in the food court (which offers a riverside view of Upper Manhattan). The Asahi beer was actually brewed in Canada by Molson, under Japanese supervision (according to the label), but many of the other products sold in the supermarket are imported from Japan. Mitsuwa was packed on both days, with customers queuing up for noodle bowls, black sesame ice cream (which is excellent, by the way) and hot Cream Yakis (also tasty) in different parts of the food court.

Martin Wolf on Lessons from Japan's "Lost Decade"

The graphic above accompanies Martin Wolf's latest Financial Times column, ("Japan’s lessons for a world of balance-sheet deflation"), and he uses it to make the point that, although the balance sheet deflation in the U.S. is a lot shallower than Japan's, the crisis is a lot broader today because it's global, i.e., Japan was still able to increase its exports (and thus ameliorate its economic situation) during its "lost decade" because there was healthy demand for those exports in countries with strong economies.

Another point Wolf makes is about the relative effectiveness of Japanese fiscal policy during its "lost decade":

[T]hose who argue that the Japanese government’s fiscal expansion failed are, again, mistaken. When the private sector tries to repay debt over many years, a country has three options: let the government do the borrowing; expand net exports; or let the economy collapse in a downward spiral of mass bankruptcy.

Despite a loss in wealth of three times GDP and a shift of 20 per cent of GDP in the financial balance of the corporate sector, from deficits into surpluses, Japan did not suffer a depression. This was a triumph. The explanation was the big fiscal deficits. When, in 1997, the Hashimoto government tried to reduce the fiscal deficits, the economy collapsed and actual fiscal deficits rose.

Something to consider when reading comments on various blogs about how Japan spent a lot of expensive infrastructure and still had a "lost decade".

"More Suley than Sully"

From Peggy Noonan's last column in the Wall Street Journal, Is 'Octomom' America's Future? (Hat tip: Doug Kass1):

It's Sully and Suleman, the pilot and "Octomom," the two great stories that are twinned with the era. Sully, the airline captain who saved 155 lives by landing that plane just right—level wings, nose up, tail down, plant that baby, get everyone out, get them counted, and then, at night, wonder what you could have done better. You know the reaction of the people of our country to Chesley B. Sullenberger III: They shake their heads, and tears come to their eyes. He is cool, modest, competent, tough in the good way. He's the only one who doesn't applaud Sully. He was just doing his job.

This is why people are so moved: We're still making Sullys. We're still making those mythic Americans, those steely-eyed rocket men. Like Alan Shepard in the Mercury rocket: "Come on and light this candle."

But Sully, 58, Air Force Academy '73, was shaped and formed by the old America, and educated in an ethos in which a certain style of manhood—of personhood—was held high.

What we fear we're making more of these days is Nadya Suleman. The dizzy, selfish, self-dramatizing 33-year-old mother who had six small children and then a week ago eight more because, well, she always wanted a big family. "Suley" doubletalks with the best of them, she doubletalks with profound ease. She is like Blago without the charm. She had needs and took proactive steps to meet them, and those who don't approve are limited, which must be sad for them.


Any great nation would worry at closed-up shops and a professional governing class that doesn't have a clue what to do. But a great nation that fears, deep down, that it may be becoming more Suley than Sully—that nation will enter a true depression.

The image above, by Martin Kozlowski, accompanies Noonan's column on the WSJ website.

1I hadn't read one of Noonan's columns in a while, but was prompted to do so by Doug Kass's quote from the one above in his new post, "Fear and Loathing on Wall Street". Kass quoted the first part of Noonan's column, which described a shuttering of shops in upscale Manhattan neighborhoods. Kass included it as a sort of contrarian indicator of sentiment in his tentatively bullish post.

Tuesday, February 17, 2009

John Hussman on "How To Climb Out of the Global Financial Hole"

From Dr. Hussman's market commentary today, "How To Climb Out of the Global Financial Hole":

•  Financials that are insolvent and are likely to survive only with large and sustained infusions of taxpayer funds should be allowed to fail in pre-packaged bankruptcies that wipe out both the shareholders and the bondholders of those institutions. Customers and depositors will not be hurt, and it won't cost taxpayers a penny. As Stiglitz notes, “you should not chase good money after bad.”

•  The government should continue to provide capital directly to large, diversified financial institutions which remain solvent but have some impairment to capital. Preferred stock is a reasonable form, though a high (possibly deferred) yield to the government is preferable to a low one (Bagehot's Rule[1]). Tight restrictions against using taxpayer capital for compensation and bonuses are certainly appropriate. These institutions include major banks like Citigroup, Bank of America, Wells Fargo, J.P. Morgan, and others, which appear to be experiencing pressure not because of insolvency, but because of uncertainty about potential future loan losses, and the ongoing availability of publicly provided capital.

•  Troubled assets should only be purchased if all of the pieces of a given issuance can be collected. The ability to aggregate all of the pieces is necessary because that's the only way the underlying mortgages can be restructured. If, for example, all of the pieces could be purchased at an average of 40 cents on the dollar (which is well above where many of these securities are marked), the underlying mortgages could be reduced by as much as 60%, making them solvent and likely to be repaid. The restructured loans might eventually even be re-sold into the market through the GSEs at no taxpayer expense.

•  The most direct method of intervening is at the point of foreclosure through the courts. One way of doing this would be to give judges the ability to write down principal, and to assign the balance as a deferred “property appreciation right” (PAR) to the lender. This would reduce foreclosure rates, preserve the value of the existing mortgage securities, and avoid concerns about fairness. A more ambitious government-sponsored program would be to make the PARs an obligation of homeowners to the Treasury administered through the IRS, asserting a claim on the price appreciation of the home or subsequent property owned by the homeowner. The foreclosure court would reduce principal, assign an offsetting PAR obligation to the homeowner, and assign the lender that same share in the Treasury's PAR Fund (basically a national pool of those PAR obligations). The PARs would then be marketable. Though they would undoubtedly sell at a discount to the face amount since not all the PARs will be repaid, they would be backed by a pool of real assets that are likely regain their value in the long-term, if not the near term. The Treasury could aggregate these claims and pay them out proportionately to the lenders, but would not even have to guarantee full payment – just enforce the claims by collecting and paying out.

The emphasis above is Hussman's. Hussman reiterates here a point he's made previously (e.g., "You Can't Rescue the Financial System If You Can't Read a Balance Sheet"), that forcing bondholders to take a haircut, or swap some of their debt for equity, would obviate the need for bailout funds from taxpayers in some cases. His advocacy of allowing bankruptcy judges to modify loans while awarding "property appreciation rights" (PARs) to lenders (his fourth bullet point above) raises a question though: if PARs existed now, would it be necessary for judges to intervene, i.e., wouldn't lenders have an incentive to write-down mortgages in return for PARs, particularly if such rights would be marketable, as Hussman envisions? Perhaps before allowing judges to re-write mortgages, the government ought to create a market for PARs and see if this helps expedite more voluntary restructuring of mortgage debt.

Another question Hussman's commentary raises relates to his point (in the third bullet point above) about the benefit of owning all the pieces of a securitized mortgage issue, i.e., that it would let the owner re-structure the underlying mortgages, making more of them viable and thus marketable. Why aren't more deep-pocketed institutional fixed income investors doing this already?

1"Lend freely at the penalty rate".

Saturday, February 14, 2009

FT Letter Writer Seconds Commenter J.K.

In the comment thread of a recent post ("Singularity U."), commenter J.K. took the editors of the Financial Times to task for their dismissive editorial about Ray Kurzweil’s "Singularity" concept. In today's FT, letter writer David Crooks offers similar sentiments:

From Mr David Crookes.

Sir, You say: “And even if researchers do endow machines with real intelligence ... why should it suddenly grow exponentially ... ?” (“Singular fantasies”, editorial, February 7).

You’ve not been paying attention in class, since this is Ray Kurzweil’s key point (and that of others, for example Vernor Vinge).

The substrate of future machine intelligence is expected to be computation, which is increasing in power exponentially thanks to Moore’s Law. The year we get a silicon FT editor for the price of a laptop, the next year we get two for the price of one. How long before the entire FT staff can be replaced by one laptop?

David Crookes,
Inverness, UK

Valentine's Day Plan A Foiled

Tonight the NJ PAC is showing the touring production of Rent, featuring Adam Pascal and Anthony Rapp, who played the characters Roger and Mark, respectively, in the original Broadway production. Given all the gloomy economic news, I figured that if waited until yesterday, last minute tickets might be on sale. No dice: it was sold out.

Rapp sings in the nasally/whiny style that for some inexplicable reason composers of many Broadway musicals feel compelled to include (often with a female singer). Pascal sings well though, and has starred in some other roles since Rent (e.g., as Radames in Aida1). Below via You Tube, is Adam Pascal singing his big song from Rent, "One Song/Glory".

1According to Wikipedia, Disney is planning a film version of Aida, with Beyoncé Knowles in contention for the title role. That would be unfortunate. The woman who originated the role on Broadway, Heather Headley, is in a whole different league vocally.

Friday, February 13, 2009

"We Don't Need to be Rescued"

The image above is from the website of my local bank, NVE Bank. Incidentally, the reason I initially opened an account at this bank was because it was listed as one of the safer banks in the country in Ravi Batra's book, Surviving the Great Depression of 1990. If memory serves, Batra's thesis was that the big build-up in federal debt during the 1980s had set the stage for catastrophe. I'll have to see if I still have the book somewhere and peruse it again to be sure.

Alloy Steel's Q1

Alloy Steel International (AYSI.OB) filed its 10-Q today for its fiscal Q1 (the fourth calendar quarter of 2008). The company essentially broke even on sharply lower sales on a year-over-year basis. From the 10-Q:

Alloy Steel had sales of $1,845,504 for the three months ended December 31, 2008, compared to $3,180,339 for the three months ended December 31, 2007. These sales consist solely of the sale of our Arcoplate product. Substantially all of our sales during the periods were denominated in Australian dollars. Sales were converted into U.S. dollars at the conversion rate of $0.67306 for the three months ended December 31, 2008 and $0.8905 for the three months ended December 31, 2007 representing the average foreign exchange rate for the respective periods.

The decrease in sales for the period is representative of the general downturn being experienced in the world economy. During the quarter, the Company's orders declined as demand for our product reduced with various mining companies announcing that new mining projects were being delayed and/or existing mining projects were being wound back until demand for commodities again increased.

This was worse than my optimistic guestimate of 1 cent per share in earnings, but not wholly unexpected, given the global economic downturn, and particularly, the downturn in the metals sector. On the plus side, the company managed to stay in the black during a difficult quarter. Back to the 10-Q:

The Company has continued to promote its product in the market place as a superior option for maintenance, as well as seeking entry into other markets which were previously limited by the Company's ability to meet the demand existing prior to the economic downturn. The Company is confident of being able to present its product well in these new markets, and anticipates additional orders will be generated from these new locations.

One of those new locations referred to above is North America, as the 10-Q notes that the company has incorporated two North American subsidiaries to handle business in this region. It would be encouraging to see the company generate some sales from companies involved in infrastructure/excavation, since those companies' bulldozer blades and truck beds are subject to wear as well.

I picked up a few more shares of AYSI earlier this week at .361.

The photo above, from Alloy Steel's website, is of an Arcoplate fan liner of the sort used in cement plants and coal-fired power plants, according to the site. I don't believe this application has been a significant source of sales for Alloy Steel yet, but perhaps this is an area its new salesmen can pursue.

Thursday, February 12, 2009

Andy Kessler on the Fixing the Banks

From his op/ed column in yesterday's Wall Street Journal, "Why Markets Dissed the Geithner Plan":

Mr. Geithner wants to "stress test" banks to see which are worth saving. The market already has. Despite over a trillion in assets, Citigroup is worth a meager $18 billion, Bank of America only $28 billion. The market has already figured out that the banks and their accountants haven't fessed up to bad loans and that their shareholders are toast.


Mr. Geithner should instead use his "stress test" and nationalize the dead banks via the FDIC -- but only for a day or so.

First, strip out all the toxic assets and put them into a holding tank inside the Treasury. Then inject $300 billion in fresh equity for both Citi and Bank of America. Create 10 billion new shares of each of the companies to replace the old ones. The book value of each share could be $30. Very quickly, a new board of directors should be created and a new management team hired. Here's the tricky part: Who owns the shares? Politics will kill a nationalized bank. So spin them out immediately.

Some $6 trillion in income taxes were paid by individuals in 2006, 2007 and 2008. On a pro-forma basis, send out those 10 billion shares of each bank to taxpayers. They paid for the recapitalization.

Each taxpayer would get about $100 worth of stock for each $1,000 of taxes paid. Of course, each taxpayer has the ability to sell these shares on the open market, maybe at $40, maybe $20, maybe $80. It depends on management, their vision, how much additional capital they are willing to raise, the dividend they declare, etc. Meanwhile, the toxic assets sitting inside the Treasury will have residual value and the proceeds from their eventual sale, I believe, will more than offset the capital injected. That would benefit all citizens, not the managements and shareholders who blew up the banking system in the first place.

Wednesday, February 11, 2009

Penny Ante Arbitrage

Asure Software, Inc. (Nasdaq: ASUR) is a money-losing micro cap stock I bought in 2007 when it appeared on the Magic Formula list. I sold it for a large loss last year, but for some reason I looked up the stock again last week. When I did, a comment on the stock's Yahoo! Finance message board alerted me to an opportunity to possibly squeeze a drop of lemonade from this lemon.

Last month, Asure Software announced that it plans to take the company private, in order to save about $1 million in annual compliance costs associated with being a public company. The company currently has about 10,000 shareholders, and, according to the press release, needs to have fewer than 300 shareholders in order to voluntarily terminate the registration of its common stock under the Securities Exchange Act of 1934. The company intends to reduce its shareholder count by means of a 750-1 reverse split, followed immediately by a 1-750 forward split, while cashing out any fractional shares at 36 cents per share, on a pre-split basis. The stock closed today at 17 cents, and the company has a market cap as of today's close of $5.29 million with an enterprise value of -$7.93 million.

Since the company isn't profitable, one question that came to mind was whether it would have the cash to pay 36 cents for each fractional share, assuming the shareholders approve the reverse merger. The company has burned through an average of about $1.34 million in cash per quarter over the last four quarters, while revenues have held fairly steady at about $2.7 million per quarter. Assuming those trends continue, and the reverse split takes place within a couple of quarters, the company ought to have enough cash to payout 36 cents per fractional share. Here's how I figure that:

Using the company's most recent balance sheet data, as of its last 10-k, the company had $10,554,000 in cash + $3,289,000 in short-term investments + $1,333,000 in net receivables = $15,166,000. Subtracting from that the company's total liabilities of $7,499,000 = $7,667,000. Subtracting $2,680,000 in cash burn ($1.34 million per quarter x 2 quarters) = $4,987,000. According to the company's 10-k, there were 10,054 shareholders as of October. Assuming that each shareholder will have the maximum number of fractional shares (749), the company will have to cash out 7,530,446 shares. At 36 cents per share, that would cost $2,710,960.

Based on that, I piggybacked on that commenter's idea and bought 749 shares of ASUR at an average price of 18 cents per share in each of a few different brokerage accounts.

The banner image above is from Asure Software's website.

Tuesday, February 10, 2009

Coming Soon

The titles of a few posts I have on deck, but haven't finished yet:

- TBT or not TBT

- More on Mohnish

- Some Bullish and Bearish Indicators on Commodities

- Penny Ante Arbitrage

Saturday, February 7, 2009

Richard Pzena's Picks For 2008

Hat tip to GuruFocus poster Abeck for this Barron's interview with Richard Pzena dated December 31st, 2007: "Opportunity Amid the Ruins". Excerpt:

Barron's: What is your downside risk [of holding Citigroup]?

Richard Pzena: There is some short-term downside risk. Looking out three years-plus, you have a really spectacular risk/reward trade. The odds that Citigroup sells for less than 30 in three years are very low, and the odds of it selling for substantially above that are very high.

Barron's: Do you feel the same about other banks?

RP: Bank of America [BAC] is the same story. They are going through a downturn, so they're going to have losses and provisions. We're estimating earnings of $3.70 a share for 2007 and $4.10 for '08. Right now, people aren't buying banks because the next quarter might be bad. Whenever investors become hypersensitive to the next piece of information, value opportunities arise.

You have to have a strong stomach to do this. I always joke about it, but the most common question we get from clients in any market environment is "don't you read the paper? How could you possibly do this, given what is going on?" And the response is, these shares don't trade at these valuations unless this kind of stuff is going on. If this proves to be fatal to Citi or Fannie or Freddie, we'll get killed. If it proves not to be fatal, as we suspect, then over the long term we're going to make a lot of money.

The article included this table listing Pzena's six stock picks (Fannie, Freddie, Citi, BofA, Alcatel-Lucent, and Capital One) and their prices as of the end of 2007.

The photo above, of Richard Pzena, is from the Barron's article linked to in this post.

"Mohnish, How Are You Feeling?"

According to Mohnish Pabrai, this is what most of his investors were asking him after he lost 60% of their money last year. For his answer, see the excerpt below from his annual letter to his investors, dated January 16th:

I did hear from a few of you in the last few weeks. While some calls and emails expressed concern over our performance numbers, the surprising thing for me was that the overwhelming majority of you were focused on asking, “Mohnish, how are you feeling?”

Well, I am actually feeling pretty good. And as Q408 unfolded, my spirits remained elevated – mainly because I remained focused on intrinsic value and was drooling over the incredible opportunity set and valuations. I was in turbo mode trying to read huge piles of 10Ks, 10Qs, annual reports, industry reports, listening to conference calls etc. – so I could pull the trigger while the prices were still incredible. And several triggers were pulled in November and December. We bought into an incredible array of assets at remarkable prices.

While it was indeed tough to watch the severe drops many of our holdings took in Q408, keeping my focus on intrinsic value, rather than fixating on the quoted market value of various positions was fundamental to staying level headed.

Pabrai isn't the only professional investor who's expressed similar sentiments when asked about his outlook recently, but I don't get this, for a couple of reasons. First, if someone asked me how I felt about the money I lost last year, "pretty good" wouldn't be my answer; "nauseous" would be -- and I just lost my own money. If I had lost 60% of the money entrusted to me by hundreds of other investors, in addition to nausea, I'd feel some remorse.

Second, it's one thing to tout the great opportunities you see in a beaten-down market, but it raises an obvious question: did you have any dry powder to take advantage of them, or have you been forced to sell your beaten-down positions to buy stocks you think are even cheaper? At least Bruce Berkowitz was candid enough to acknowledge (on a recent conference call) that that's what he's been doing, for the most part (selling cheap to buy cheaper). If that's been the case with Pabrai too (and I assume it is, considering that Pabrai has allegedly used Berkshire Hathaway stock as a "placeholder" for cash), then his zeal for current bargains ought to be tempered by some regret for not keeping more cash on hand to take advantage of them.

About the image above:

In his book The Dhando Investor: The Low Risk Value Method to High Returns, Pabrai offers the story of the end of Abhimanyu, a hero of the Hindu epic The Mahabharata, as metaphor for the difficulty of selling a stock. In an nutshell: Abhimanyu uses a technique he overheard1 from Krishna to penetrate the spiral chakravyuh battle formation of his enemies, the Kauravas. Unfortunately, he never learned how to break out of the chakravyuh, so he has no exit strategy. He fights valiantly, one against many, and kills a number of Kauravas, but ultimately gets killed. I believe the image above2, from a Geo Cities site, depicts this.

1Please see the second comment by Ravinsu for elaboration.

2Replaced as per Ravinsu.

Thursday, February 5, 2009

Are Liberals Less Inclined to Pay Their Taxes?

That question occurred to me on reading the news that a fourth Obama Administration nominee, Labor Secretary nominee Rep. Hilda Solis, has unpaid tax issues (The Washington Post: "Solis Senate Session Postponed in Wake of Husband's Tax Lien Revelations"). This news, of course, comes after the revelations of unpaid taxes by Treasury Secretary Timothy Geithner1,2 (pictured above), former HHS Secretary nominee Tom Daschle, and former "Government Performance Czar" nominee Nancy Killefer. If coincidences don't come in threes, as the saying goes, then they don't come in fours either.

At first blush, it might seem counter-intuitive that affluent liberals would be less inclined to pay their taxes, since they tend to advocate for higher taxes on the affluent. Advocating for higher taxes on the affluent and being eager to pay them yourself are two different things though. Warren Buffett, for example, has famously lamented that he doesn't have a higher tax liability, and yet he deliberately avoids the capital gains tax on the shares of Berkshire Hathaway he donates to the Gates Foundation. I would be interested in any data that compared the level of tax compliance by conservatives and liberals, but I wonder if a similar dynamic is at work with taxes as with charitable donations.

Just as liberals tend to advocate for higher taxes on the affluent, they also tend to advocate for more government assistance to the less fortunate. While this might lead one to believe that liberals are more generous than conservatives, Arthur C. Brooks, professor of public administration at Syracuse, found that conservative households donate 30% more to charity than liberal households. Could it be that liberals feel less obligated to donate to charity or fully comply with tax laws because they feel that their advocacy for more progressive taxes and more generous welfare spending absolves them of some of their responsibility to contribute personally? Perhaps they feel they "gave" at the ballot box?

The photo above, of Treasury Secretary Timothy Geithner, is from the Affordable Housing Institute's website.

1I suspect Geithner's tax avoidance may have been motivated by what David Brooks has termed Status-Income Disequilibrium. As a high official at Treasury, the IMF, and then the New York Fed, Geithner earned a comfortable salary -- one higher than perhaps 99% of Americans -- but a pittance compared to some of the CEOs over whom he wielded authority. He probably thought he was sacrificing enough for the common good by renouncing more lucrative prospects in the private sector and working for the IMF instead, so why should he lower his take-home pay even more by paying his self-employment taxes?

2Atlantic blogger and journalist James Fallows, a former Carter Administration official and liberal in good standing, Had this to say about Timothy Geithner's non-payment of his taxes ("A Word about Timothy Geithner" -- scroll about a quarter of the way down for this):

I do not believe, and will never believe, that his failure to pay his own self-employment tax while at the IMF was an "oversight" or a "mistake." I have many many friends who have worked for this and similar organizations. I have myself over the years juggled the complexities of what is self-employment income and what is W-2 income and how to handle income from non-US sources -- and I have a lot less financial acumen than any Treasury Secretary aspirant should and must have. (Though I also use Turbo Tax!) Not a single person I have known from the IMF or similar bodies, not a one, believes that Geithner could have "overlooked" his need to pay US self-employment tax. When I have received similar income from international sources, the need was obvious even to me -- and I wasn't receiving and signing all the forms to the same effect Geithner would have gotten from the IMF. I could go on with details but I'll just say: if this were a situation more average Americans had experienced personally, he would not dare make his "mistake" excuse because everyone would say, "Are you kidding me???"

Queens Congressman Rips the SEC

Hat tip to Brian Beutler, who's filling in for Matt Yglesias on Yglesias's blog: below is Rep. Gary Ackerman, Democrat of Queens, NY, going off on a few SEC officials for missing the Madoff fraud, even after Harry Markopolous had pointed it out to them (see "More on Madoff" for Markopolous's letter to the SEC).

Wednesday, February 4, 2009

Singularity U.

From yesterday's Financial Times, "Google and Nasa back new school for futurists". Excerpt:

Google and Nasa are throwing their weight behind a new school for futurists in Silicon Valley to prepare scientists for an era when machines become cleverer than people.

The new institution, known as “Singularity University”, is to be headed by Ray Kurzweil, whose predictions about the exponential pace of technological change have made him a controversial figure in technology circles.

Google and Nasa’s backing demonstrates the growing mainstream acceptance of Mr Kurzweil’s views, which include a claim that before the middle of this century artificial intelligence will outstrip human beings, ushering in a new era of civilisation.

To be housed at Nasa’s Ames Research Center, a stone’s-throw from the Googleplex, the Singularity University will offer courses on biotechnology, nano-technology and artificial intelligence.

The so-called “singularity” is a theorised period of rapid technological progress in the near future. Mr Kurzweil, an American inventor, popularised the term in his 2005 book “The Singularity is Near”.

Proponents say that during the singularity, machines will be able to improve themselves using artificial intelligence and that smarter-than-human computers will solve problems including energy scarcity, climate change and hunger.

So much for the good news. The article continues:

Yet many critics call the singularity dangerous. Some worry that a malicious artificial intelligence might annihilate the human race.

After numerous sci-fi movies and TV shows have dramatized this scenario, from 1970's Colossus: The Forbin Project (the subject of the movie poster above) to current TV shows Terminator: The Sarah Connor Chronicles1,2 and Battlestar Galactica1, we won't be able to say that we weren't warned.

The image of the movie poster above is from

1Critically acclaimed.
2Consistently entertaining.