Secondary Offerings, Debt, and Defaults

Minyanville Professor David Nelson and Minyan Peter were talking about secondary offerings today. Let's take a look.

Professor Nelson: Shipping Secondaries

One by one the Dry Bulk Shippers are reporting blow out quarters. However, another pattern seems to be developing under the surface. Shortly after reporting and getting a big bump from the EPS reports, they've been announcing secondary's. Last week it was TBS International (TBSI) and this morning it's Genko Shipping (GNK).

Minyan Peter:Wynn, Lose or Draw

The comments on the shippers issuing equity reminds me of Wynn Resorts (WYNN) issuing stock last September. Take a look at the Wynn chart. It is yet another example of a very simple rule. CEO's only issue equity in two situations - when they absolutely have to and when they are stupid not to. With grains peaked or peaking, the shipper CEO's are doing what they should do - issuing very expensive stock while the story still works. Now having said all of that, also take a look at Wynn's share count since September. It's down significantly. How? They keep buying back those same shares they sold last September at lower and lower prices - but, more importantly, why? because fewer shares boosts EPS, which, if you are on your way down in the cycle, buys time. You'd think investors would learn. But it works every time.

Wynn Daily Chart



click on chart for sharper image

Debt, Dilution, Default and Denial

Profesor Sedacca was also talking about dilution today in Debt, Dilution, Default and Denial.

Debt

Debt is like a drug. When used properly, it can help the sick or enhance the life of a healthy individual. If abused, both can result in addiction and despair. But now, the use of debt has become so widespread and has been so incredibly abused that we now find ourselves in quite a nasty predicament.

Dilution

As a result of their own greed, banks and brokers have been forced, on a global scale, to write down more than $315 billion since the crisis began last summer. Most of the write-downs have been confined to the sub-prime sector to date, but I'm highly uncomfortable that the crisis, in the end, will be confined to sub-prime.

In fact, we're already beginning to see strains on other parts of the credit markets. The problems stretch all the way from credit card receivables, Alt-A loans, prime loans, auto loans and motorcycle loans. The problem is not at all contained, as many analysts, economists, TV commentators and other "hopers" would like us to believe. Unfortunately, contagion is here, perhaps for a while. To make matters worse, when we add exploding commodity prices and a rising unemployment rate to the picture, the takeaway is far from optimistic.

As a result of all the write-downs that have occurred, many financial institutions have been forced to come to market with common equity, convertible preferred and straight preferred deals. Companies on this list include the likes of Merrill Lynch (MER), Fannie Mae, Freddie Mac, National City (NCC), Regions (RF), Fifth Third Bancorp (FITB), MBIA (MBI), AMBAC (ABK), J.P. Morgan (JPM), Lehman Brothers (LEH), Citigroup (C) and so on.

Some of the companies, like National City, have diluted existing shareholders by 50% just to stay in business. The same, sadly, can be said for MBIA and AMBAC, two municipal insurers that got burned when they entered the vague world of Credit Default Swaps and CDO’s.

For what it is worth, I highly doubt that AMBAC and MBIA will survive this crisis as they now have nearly three times their shareholder equity in "deferred tax assets." Even Freddie Mac disclosed it now has deferred tax assets on its books, a potential sign of financial stress.

It is clear to me that what many of the aforementioned companies should be doing is not what they are actually doing. Take Merrill Lynch, for example. Merrill has said on several occasions that it doesn't need to raise capital, only to raise billions of capital a week later, paying as much as 8 5/8% for preferred stock.

If you owned your own company, business was slowing, your cost of capital was rising, profits disappeared, you were writing down the value of your net worth and assets, employees were leaving and you were levered up to your eyeballs, what would you do? A prudent investor would cut dividends to shareholders, reduce headcount, try to cut leverage and find a way to raise equity even if you dilute your own holdings just so you can fight to live another day.

Those companies that resist these measures will live to regret it, in my opinion, even to the extent that their stubbornness to please Wall Street and investors over the near term could result in insolvency.

Defaults

Much of the data I've presented is not at all positive, but to ignore the facts is to bury one’s head in the sand and burying one’s head in the sand isn’t any better at producing exceptional investment results than hoping.

Why wouldn’t someone mark their bonds to the real price where they would trade if they were to be forced to sell? Why would so many firms lever up and pay dividends they can’t afford instead of simply raising capital to bolster a weak balance sheet while they can? I can sum up the answer to that question, which is also the answer to "Why are so many investors again embracing all sorts of risk - credit risk, structure risk, etc.?"

Denial

When I began worrying about credit way back in 2004 (my credit concerns actually date all the way back to 2001), I actually hoped that my analysis would be wrong. The cards were laid out in a very organized fashion and the odds of being wrong about credit were not likely. Where are we now? Now that even more debt has been created, more structured financial vehicles have been created than I could have ever imagined and the write-offs have begun to occur, I am afraid that the next waive of delinquencies and bankruptcies will be more widespread from the corporate boardroom, to Main Street and Wall Street, and to living rooms across America and, more likely, the whole world. If one thinks that the only place greed and avarice exists is within the confines of the U.S.' borders, they will likely be mistaken.

I have been asked for an outlook for what I think might occur over the next six to 12 months. Considering this is an election year with a lot at stake and with many voters in both parties (at least the ones I talk to) going to vote for the candidate they dislike the least, this could further pressure the dollar, as will reckless money creation and other fiscal and monetary policies. It seems to me that the only way out of this mass is for a series of Bear Stearns-like events, and other events, like National City of Cleveland, which was at the brink of losing the chance to raise capital.

All I can say is that I think whichever Presidential candidate is voted into office in November will be "one and done" as no matter who wins, they will be facing a problem that started a couple of decades before.

I think a "Perfect Storm" has formed and that if you want to use a hurricane as an analogy, the outer bands of the storm hit the U.S.' shores in the August 2007-March 2008 timeframe. The real issues are closer to the eye of the storm, which is likely an early 2009 event.

I continue to be cautious (not bearish) and to scour the landscape for opportunities in both my long only and hedged strategies. If I'm wrong, I'll still earn a modest rate of return, but if I'm correct, and have my capital intact as the eye of the storm hits, that's where the real money will be made.

Denial continues at Citigroup and many other banks. Denial also is running rampant among stock market bulls. The Eurodollar futures are pricing in future rate hikes as is the future is rosy. I disagree. So does Rosenberg at Merrill Lynch who is calling for 1% interest rates (See See Rosenberg: Debunking Five Myths.)

Meanwhile consumer sentiment is heading south in a major fashion as noted in Consumer Sentiment: Is the Worst Yet To Come?

Someone is wrong here and I do not think it is the bears.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List