Vad's Best Ideas

Part 2

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Continued from "Are we there yet?"

What came yesterday was a real shocker- not only the losses were significantly larger than expected $800M as of November 30th (could exceed $1.5B by the end of January) but the liquidity crunch got so bad that MGI had to renegotiate the debt that was put in place just a few months ago to pretty much junk rates and had to also sell over a $1.3B in securities in a "fire sale" with real losses now hitting the book and cash balances...And in addition all the equity is going to be raised at prices significantly lower than current trading price...

At the end MGI might have to give up and astounding 60-70%+ of the total equity to new investor just to stay alive...Case closed?

But what seems to be really bad, is that contrary to the common logic- it does not seem like the supposedly safer vintages are really any safer, or that the problem is only related to the residential real estate related securities, or that it is easy or even at all possible to raise relatively safe debt now, even if it is backed by an asset that consistently cash flows $200M and is growing at 20% a year...And we are talking about leverage of only 3-4 times that projected earnings stream...A year ago multiples like this were assumed to be conservative- bad news for any outstanding private equity deals out there as well as for any boought firms that did not raise debt using "covenant lite" loans...

Yes, it is possible that the lack of the initial disclosure of the details on the entire portfolio and the lack of response to the Euronet's offer have triggered the ensuing fiasco. And I do think that multiple lawsuits will follow within days and that CEO's days are numbered, but it won't really help the investors who have lost a fortune...Even I personally have lost some money after initially having large gains on this company in 2007.

I am also afraid that MoneyGram story could turn out to be a really ugly indication of things to come... Just how bad it could really get in the next few weeks is still open for discussions, but while my forecast for 2008 assumed a world wide market downturn- I now think the situation might be even worse than one could have imagined...We clearly still have some severe froth in several emerging markets (main one is China). And it is still safe to assume that any stock that has a high leverage and even, God forbid, has a lot of asset based securities on the balance sheet (think banks and investment banks) could be in for a rough ride in the months to come. Stay away from financials- even though some regional banks seem like a good deal on the surface- after the MGI's fiasco- I don't think it is really possible to reliably value any complex asset backed product right now...

And finally let's not forget- while I believe that we have already entered or might be in the process of entering a full blown recession- not everyone is pricing in the same outcome quite yet. Only when majority of market participants agree that we are going into the "R" word- the risk/return trade off of owing stocks might finally tilt into investor's favor. For now- bonds, or bond ETFs (TLT, TIP, SHY etc), short selling individual stocks and some of the safer not leveraged non cyclical and non consumer discretionary long positions could possibly offer some safety in the weeks to come...

Trade safe and cheers,
Vad (former "Dishwasher" now simply a "Skeptical Economist")

P.S. I am in the process of setting up my new blog and getting ready for the MSN contest which turns out requires a lot of writing even prior to start which means I'll probably less attention to the virtual portfolios for the next few weeks. But I'll keep posting regularly here and will share my views on any of the fun developments in the next few weeks.

P.S.S. Also don't forget to use trailing stop losses on any long positions- it always better to be safe than sorry... By the way, sell offs also mean better upside once market stabilizes so don't panic or worry - protect whatever gains you might have and have enough in liquid securities to jump in the high beta stocks once the right time comes.