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"If a fellow isn't thankful for what he's got, he isn't likely to be thankful for what he's going to get."
Frank A. Clark

What a disastrous month has it been so far for investors...One sector after another seem to be collapsing one day, recovering a bit the next day only to set a new low a day later. And I wish there were good news on the horizon...So far I don't see many.

Today's MoneyGram collapse was significant for many reasons. The scary part about the whole story is that it shows just how bad the things could get even for a company with a fundamentally great business when financial system does not function properly. I think this company offers a great look behind the current market situation...

Let's begin with a simple fact- according to the company's release yesterday- the underlying fundamental business of transferring money around the world can't really get much better. Revenue growth for the latest quarter was roughly 25% and agent growth about 30%. So with roughly $150M in earnings and the solidly double digit growth rate the core business alone should be worth about $3-$3.5B.

So far so good- so how did it get so ugly? The whole mess came from a relatively tiny business of processing official checks and money orders. The business model is quite simple - hold the funds for a few days and earn the float income why they are in process. Ok, so you might ask where is the catch and how did could the situation get so bad so quickly? Quite simple- the only way to really grow this segment for MGI was to increase the net investment margin, so that's exactly what they have done- tied the compensation of the Treasurer to the net interest spread??? Hello?? Could we get a lawyer in here? Lesson number one -people respond to incentives- they always do what's gives them a higher paycheck especially if it mean taking a lot of risk with not their own money and that's the end of story...

Ok, let's now shift to the second part- how could so many sophisticated investors like Blum and Co, Fidelity and many well known value hedge funds get into the red so deeply, even while knowing what was going on in the credit markets. This is were the story gets a bit murky and starts to smell like a clear lawsuit - short introduction- as of the end of the third quarter MGI held roughly $5.3B in asset backed securities out of which they classified only $1.5B as having real exposure to the lock down in the residential debt market.

MGI wrote down almost $300M in Q3 but never really sold any securities because according to the management the cash flows didn't really confirm the market's fears. So the rest of the portfolio was widely assumed to be relatively safe, because it wasn't tied to the residential market and also was of more conservative (as assumed by most) 2004-2005 vintages.

So here how the common logic worked- if one assumed that eTrade's debt sale of 27 cents on the dollar represented a theoretical floor on the valuations of most debt securities, one could have also reasonably expected that as much as 70% of the "riskier" MGI securities could be written off with $700M in paper write downs scheduled for Q4. Yes, the requirement to have a positive net worth was a well known risk, but with $400M in book value and freshly raised $150M of debt, the assumed equity need of $300-400M didn't really change the picture that much assuming they raised it at a slight discount to the trading price.

So all-in-all value investors like myself have calculated that even with potential $1B in total loses there was still significant upside left in the deal. Rough calculations goes like this- $3B payment transfer business valuation (lower end of the initial range because of the additional interest on the debt) minus $1B ($700M) after tax losses with debt in the sub $750M and some potential slight equity dilution, $20 a share target price did not seem unreasonable vs $13-14 a share price then trading price...

Continued in Part 2