Monday, September 13, 2010

Bought 50 PKM at 24.84/Bought 50 FBNC at $12.01/Sold 50 SBIBN at $24.95/Explaining Low Valuations of Large Cap Tech Stocks

J.P. Morgan's analysts believe that the semiconductor industry is experiencing an inventory correction similar to 2004 and 2006 and recommends that investors withhold buying in the sector until the 4th quarter or later. Barrons.com According to Morgan, valuation levels do not matter, which is typical Wall Street group think now, since no one knows how low the near term earnings estimates will go. The three analysts who offer that advice are Christopher Danely, Shaon Baqui, and Venk Nathamuni.

No one knows for certain when the worm will turn against bond investors. As noted in an article in Saturday's WSJ, the last ten days gave owners of the 10 year treasury a taste of what happens when the long term secular bull market ends. Over that ten day period, the 10 year treasury lost about 2.5% of its value which is equivalent to almost one year of its interest payments. Given the low rates prevailing now, it would not take much of a rise in rates to cause a decline in a bond's value equivalent to an entire year of interest payments.

The new recommendations on Bank capital levels by the Basel Committee on Banking Supervision were announced over the weekend. Group of Governors and Heads of Supervision announces higher global minimum capital standards The new recommendations would be phased in by January 2015. The Tier 1 Capital minimum would rise from 4% to 6% with a 2.5% "conservation buffer". www.bis.org .pdf "The purpose of the conservation buffer is to ensure that banks maintain a buffer of capital that can be used to absorb losses during periods of financial and economic stress. While banks are allowed to draw on the buffer during such periods of stress, the closer their regulatory capital ratios approach the minimum requirement, the greater the constraints on earnings distributions." In addition, the committee recommends the institution of a 0 to 2.5% counter cyclical buffer during good times.

The Los Angeles Times is reporting that the tea party candidate, Christine O'Donnell is "within striking distance" of beating the establishment GOP candidate for the U.S. Senate seat vacated by Joe Biden.

The latimes.com has a good article on the nation's unemployment situation and the likelihood of a long slog for the unemployed to find work.

1. Explanation for Low Valuations of Large Tech Stocks: Eric Savitz makes an effort to explain why technology stocks have fallen to their lowest valuation levels since 1991 relative to the S & P 500. Barrons I would not attempt to conjure up rational reasons for either the current valuations or the valuations placed on the same companies in 2000. Such an effort assumes that investors are rational and make sound judgements based on all material and available information, a preposterous theory. Efficient Market Hypothesis as Hokum Efficient Market Theory: Do Humans Really Behave Rationally-Seek out Relevant Information & Then Process Information With Good Judgment? I recall reading in 1999 an abundance of "rational" reasons for the clearly absurd stock valuations prevalent at that time. In retrospect, I doubt that there is anyone now who would offer any justification for the tech stock valuations during the bubble years. What will be the consensus opinion in five to ten years about the current valuations of large tech stocks? Item # 3 Large Cap Valuation Strategy-A New Long Term Strategy

Sure, most of the large cap technology companies do not pay dividends, but that was true in 2000 when investors bid up CISCO to around 150 times pro forma earnings. Intel, whose dividend yield at its current price is close to the yield on a thirty year treasury bond, has suffered in the recent downdraft in a similar fashion to Cisco, the penultimate cash hoarder among the tech titans. I would submit that the best explanation is that investors were not making rational judgments in 2000 and the same is true now.

Without a doubt, more intelligent and shareholder friendly decisions need to be made by these large companies on how to allocate capital. Many of the companies used shareholder cash to acquire small firms at expensive prices, unable to develop the innovations offered by those companies in house at a far lower cost notwithstanding having huge R & D budgets and far more employees.

And, as noted in Andrew Bary's column, maybe it would be better for the tech companies to pay out a large percentage of their profits in the form of regular quarterly dividends, sort of like utility companies. If HP increased its payout to 40% of its profits, the dividend yield would be 4.6% yield at a $38.82 price, Barrons. Such a policy would have to be imposed on these companies by the shareholders which is not likely to ever happen since most shareholders are lemmings with the words "sucker" and "kick me" tattooed on their foreheads. Before the era of liberal stock grants to employees, corporate jet fleets, outlandish pay packages for mediocre performance, shareholders had a common sense view that two things generally happen with their cash kept by the corporation, it will be stolen by management in some legal or not so legal way or it will be wasted on ill-begotten ventures and acquisitions.

And, rather than spending boatloads of cash to acquire smaller firms with worthwhile innovations, possibly HP can learn to do what Apple has already done, innovate in-house. (HP paid 10 times revenue for 3Par) As noted by Bary, it is hard to see any real benefit to the massive amounts spent by Cisco to repurchase its stock, which may be due at least in part to the valid perception that investor cash is being used to avoid dilution originating from generous option grants.

And it was disconcerting last night to read reports that HP has set its sights on another small company, Arcsight (ARST), with 181 million in annual revenues, for around 1.5 billion. WSJ.com I bought shares in HP for the first time last Friday: Bought 50 HPQ at 38.2

2. Bought 50 PKM in the Roth IRA at $24.84 on Friday (see Disclaimer): PKM is a trust certificate that contains as its underlying bond a trust preferred security issued by AFC Capital, a Delaware Trust, controlled by the Hanover Insurance Company. The security owned by AFC Capital was a Hanover Insurance junior bond. I did not realize it until recently, but Hanover dissolved the AFC Capital trust and delivered to the owners of that Trust Preferred the Hanover junior bond. So PKM now represents an undivided beneficial interest in a Hanover junior bond, rather than a beneficial interest in a trust preferred issued by AFC Capital that had as its underlying security the Hanover junior bond. Simply put, Hanover eliminated a legal layer. This is explained at page 13 of Hanover's last filed 10-Q as follows:

"AFC Capital Trust I issued $300.0 million of preferred securities in 1997, the proceeds of which were used to purchase junior subordinated debentures issued by the Company. The Company liquidated the Trust on July 30, 2009. Each holder of Capital Securities as of that date received a principal amount of the Company’s Series B Junior Subordinated Deferrable Interest Debentures equal to the liquidation amount of the Capital Securities held by such holder. These junior subordinated debentures have a face value of $165.3 million and $165.7 million as of June 30, 2010 and December 31, 2009, respectively, and consistent with the capital securities, pay cumulative dividends semi-annually at 8.207% and mature February 3, 2027"

I previously. purchased 100 PKM at $17.80 in a taxable account and 50 in an IRA at $17.50. Bought 150 TC PKM RB helpfully added that it believes $17.50 is a lower price than $24.84, but maybe the Nerd has a different opinion on that subject. RB is not a whiz with numbers like the oh so serious Young Stock Stud. Of course, RB would have bought 10,000 shares of PKM at $17.50 and would have sold 9,000 of those shares at the price Mama's Boy paid for 50 shares on Friday. LB, always quick with a reply to LAME BRAIN'S gibberish, noted that HK would be living under a bridge, eating his meals at the Nashville Rescue Mission, for the last 40 years if the NIT WIT had been in charge of the trading desk and would not have $17.5 to invest, let alone $175,000.

After those purchases of PKM on the same day back in July 2009, I sold 50 of the 100 shares purchased in the taxable account. Pared PKM I still own 50 shares bought at $17.8 and $50 purchased at $17.5. The current yield on shares bought at a total cost of $17.8 is around 11.23%. The 50 shares bought at $17.5 are still in a regular IRA and have a current yield of about 11.42% and a YTM of 12.46%.

The TC and the Hanover junior bond mature on 2/3/2027. Interest is payable semi-annually, and the last ex interest date was in August. Interest can be deferred for up to five years provided the stopper provisions are not activated by the payment on, or purchase of a junior security. As with other TPs, any deferred interest accumulates interest at the coupon rate. The coupon on PKM is 8% on a $25 par value. www.sec.gov Basically, at my $24.84 purchase price, my current yield will be close to the 8% coupon.

More information about Hanover can be found at the Reuters profile page. The current consensus estimate is for an E.P.S. of $2.85 in 2010 and $4.27 in 2011. THG Analyst Estimates Hanover is paying a common stock dividend which is always an important point for an owner of a TP.

Hanover was formerly known as the Allamerica Financial. This is a link to the firm's last filed Form 10-Q. Hanover's debt is listed at page 13.

The underlying Hanover bond is rated junk by all three agencies: Ba1 by Moody's and BB- by S & P. FINRA The Hanover senior bond maturing in 2020 is rated investment grade: FINRA That bond closed at over a 10% premium to its par value, and has a current yield of 6.7% based on the last trade on 9/10.

Sometimes the Finra link does not work on this bond after a period of time. Of course, anyone can find this information by going to FINRA, entering the symbol THG, and then scroll to "bond". Search Results The underlying bond last traded in May 2010, so the trade data is not helpful in evaluating the current price of PKM.

I also own a functionally equivalent trust certificate (KRH) which contains the same bond. Bought 50 KRH in IRA at $18.62. That one has a $25 par value too but the coupon is lower at 7.75%. On Friday, it had the lower current yield, which explains why I chose to add to PKM rather than to KRH. If KRH approaches closer to its par value, I may sell it and then keep the PKM just added to the Roth as its replacement.


3. Bought 50 FBNC at $12.01 on Friday (Category 2 Regional Bank Stocks' Basket Strategy)(see Disclaimer): I previously bought in late August 50 shares of FBNC at 12.58. I have nothing to add to that post. As with the purchase of another 50 of Renasant last Friday, I may elect to sell the higher cost shares on a pop and keep the lower cost ones, using FIFO accounting. In the meantime, I am okay with owning 100 shares of this N.C. based bank.

4. SOLD 50 SBIBN AT $24.95 on Friday (see Disclaimer): I was satisfied with a small gain on the shares, and did not see any reason to wait for the upcoming quarterly interest payment when my objective was realized by selling the shares. SBIBN is a TP from a trust controlled by Sterling Bancshares and I bought those 50 shares at 23 in August. I will consider buying back those shares at below $22.5 provided there is no material deterioration in the credit quality of this bank. I also own the common shares, SBIB, as a Category 1 holding in the regional bank basket strategy.

1 comment:

Rick said...

While HP could have certainly developed the 3PAR technology in house they would not have been able to keep their competitors from getting it... Does that make it worth $3B? Maybe not, though how long would it take HP to develop the technology in house?

It really isn't that simple though. 3PAR fills a small hole in HP's portfolio of products that could help them to sell other products and allows them to provide a "total solution" for a customer.

Dell could have used this to gain leverage with HP customers to help Dell win other business such as the high end server's.