What got me started was reading MBIA (MBI) CEO Jay Brown's comments to Hank Paulson on the potential usefulness of the TARP Guarantee Program. Brown is on the topic of synthetic CDOs, kind of esoteric and not something I had given too much thought to. I was aware that some investors might prefer their exposure to certain asset classes in synthetic form, much as James Bond preferred his martinis shaken, not stirred. A matter of taste, really, and not that important.

Here is what Brown had to say:

We believe that it is critical that eligible collateral be in securitized or certificated form. Neither "whole loans" nor synthetic exposure on a referenced basis should be accepted. More specifically, synthetic exposure is a position taken in credit default swap form where the party does not have an insurable interest in the underlying asset, but rather only references an asset through their derivative, hence suffering from an inability to deliver under the Direct Purchase Program of TARP...

The volume of synthetic assets created, transacted and insured among market participants could easily overwhelm the capacity of this program. In addition, guaranteeing positions in these contracts has no direct impact on the real economy. When these contracts settle in the ordinary course or as a result of losses in the reference portfolios, no wealth is created or destroyed - it is merely a "zero sum" game. MBIA has been a participant in this part of the market, guaranteeing over $100 billion of such contracts. Nevertheless, we strongly urge that the Treasury avoid extending the Guarantee Program to synthetically referenced assets. If the performance of underlying mortgages improves, the synthetic assets and derivatives based on them will take care of themselves.

First, as a shareholder I was not pleased. Readers are familiar with my concerns about "naked" CDS, that is, CDS that are not supported by an insurable interest. I believe these deals may create moral hazard. Eric Dinallo, NY State Superintendent of Insurance, in an effort to bring some degree of regulation to the CDS market, determined that CDS are insurance when supported by an insurable interest. "Naked" CDS in his analysis fall into two classes, grey area cases where there might be some social benefit, and unregulated gambling.

MBIA will not be providing future protection in CDS form, and from the tone of the above I doubt they will provide any form of credit insurance in the absence of an insurable interest, going forward. As an investor, I am sorry that they got involved in the zero sum game, but I have been hopeful that in the absence of collateral requirements they can wait this one out.

But the 100 billion from one company, at stake in a zero-sum game, with no direct impact in the real economy, got me thinking: what is this stuff, how much of it is there, and what if it does have an impact in the real world economy? What was the involvement of other companies in the financial sector? Then I went on to other interests.

Today in the WSJ we learn that AIG had about 10 billion of this stuff. The Maiden Lane III facility, which is supposed to buy the assets underlying AIG's troubled Super Senior CDO portfolio, has a problem: the insured party does not own them - the exposure was in synthetic form. The WSJ article mentions "Abacus" and Goldman Sachs: a search of the terms reveals the following from a Moody's downgrade announcement: "Abacus 2005-CB1 is a synthetic collateralized debt obligation (CDO) that closed on Dec. 7, 2005 created to enter into credit default swaps with Goldman Sachs Capital Markets." Making bets with Goldman Sachs hasn't been profitable to anyone, as far as I can see, it's like betting against the house, the odds are in their favor. Why it would be a suitable investment for anyone is beyond me.

Personally, I prefer to take my exposure to certain asset classes in natural form: "no synthetic, please."

Comments: View Comments |  Wednesday December 10, 2008  |  Stocks: AIG, MBI,

Part of everybody's set of investment beliefs, either consciuos or unconscious, is the idea that the market always comes back - after a bottom, there will be new heights to scale, higher than anything which preceded it.

Few hold such beliefs for individual stocks, having noticed over the years that large and profitable companies can disappear in a flood of red ink, litigation, and disappointment.

But for the market as a whole, most of us believe in our hearts that it always come back: first it goes down, then it goes up, but it always goes higher in the long run. If that does not play out as projected over the next 20 years, there are going to be a lot of disappointed retirees, myself among them.

Mr. Market has an opinion, I think. He studies the words and actions of those who are supposed to protect us from a meltdown, a global economic catastrophe, and takes a guess at whether the nostrums, remedies and panaceas actual or proposed will have the intended effect of getting everything back on track again. If the actions work, the market will go back up, same as it ever did. If they don't, it will just keep getting worse, forever.

Right now, Mr. Market is not sure...

I am mildly hopeful, based primarily on the Federal Reserves suggesting that they have more arrows in their quiver, above and beyond simple rate cuts.

Comments: View Comments |  Thursday December 4, 2008

Pericom Semiconductor (PSEM) is a high tech value play - the company has a genuine technological business with real sales and income, but also features a lot of cash and investment securities. At Friday's close of 5.41 it is trading at less than its tangible book value of 7.98. TTM P/E checks in at 8.5. At these prices, it is safe to buy and hold, waiting for the recovery in semiconductors, whenever that may occur. I have had good results investing along these lines, specifically back after the tech crash.

Overview - Pericom specializes in serial connectivity. Their website includes an Investor Fact Sheet http://www.pericom.com/pdf/fact/PSEM_financial_facts_Q109.pdf. R&D amounts to about 10% of sales and produces 6-8 new products in a typical quarter. They do business with the likes of Hewlett Packard (HPQ) and Dell (DELL). Five year revenue growth has been 18% (GARP too!) and margins have improved in recent years.

It trades just slightly above the per share value of its cash plus short term and long term investments. Cash and investments is in excess of operating capital needs and could be used for a nice special dividend, or to repurchase shares, never a bad idea when a company's share price falls below tangible book. The company has a repurchase authorization outstanding. Acquisitions are possible: management looks at deals as they become aware of them.

Strategy - From the 2Q 08 transcript: "For the last few years, we've focused our efforts on enabling the transition from parallel to serial connectivity in computer, communication, and consumer electronics systems. This has helped us achieve a unique position compared to many other semiconductor companies. We've achieved success so far on providing high-speed serial protocol solutions for digital video, auto-mobility devices, and high-performance PCs and servers, end markets that we believe will continue to grow at a healthy rate."

"Given the tangible productivity benefits from faster high-quality connectivity, we believe our products provide cost-effective differentiating solutions to key OEMs. We believe this has been a key factor for our continued growth in the current market."

Growth and Margins - up to the end of the most recent quarter, management had been able to increase revenues faster than SG&A, meanwhile increasing gross margin. Net income as a percentage of revenue increased from 5.5% for fiscal 2006 to 10.22% for fiscal 2008. Revenues increased 16.5% and 32.7% year over year during the same time span.

Weak Guidance - After reporting a very respectable 1st quarter 2009, guidance is weak, based on a sudden slowdown in bookings and lack of visibility. This, together with the overall poor performance of the equity markets, tanked the stock. 2nd quarter guidance works out to revenues of 38 million and EPS of .09, vs. 44 million and .15 for the quarter just ended. Looking back over the punishing 2001-2003 period, it appears management kept expenses in line and R&D intact, so I expect they can manage through the coming downturn: they have the resources.

Target - over the past ten years, PSEM has always traded at above 1.5 P/B at some point during the year, and is now at a ten year low on that metric. Using P/S, a midpoint target would be 20 per share, using P/B, a midpoint would be 12. Assuming some kind of economic recovery, my two year target would be 12. Under favorable economic conditions, that target would be around 20 per share.

I have opened up a starter position and plan to monitor quarterly, looking for management to control expenses, maintain R&D, and implement their strategy successfully. If and when visibility and outlook improve, or if prices drop without cause, I will attempt to enlarge the position at a favorable price.

Comments: View Comments |  Monday December 1, 2008  |  Stocks: PSEM,