So you are probably wondering how the gating by 7 mutual funds of about 20B could spread through the system? Good question, shows you are paying attention. You see most of the investors in these funds were not individuals like you and me but were other mutual funds that were seeking out yield. So let's say that Alpha Fund is in one of these gated property funds. It can't get it money back but it is cool because it has money for redemptions so it feels no pressure. No pressure until the property funds cut their value by 20% and you have to reflect that in your statement next month which is exactly what the property funds did in July. So some smart investor in Alpha Fund is going to look at the investment sheet and realize Alpha can't get its funds from the property fund. So the first thing he does is get out now while he can and then he tells all the laggards how smart he was on some Yahoo message board and panic ensues as Alpha crashes. This is what happened in 2008, check out The Big Short. I can't wait for the sequel. I plan to play the guy who spills the beans. I'm writing the script right now so we will have to cut this short (pun intended).
Let's check out a few predictions. I said last fall that auto sales would slow down in March. Missed that one as it happened in April. After the last CC, I told you SIRI would rally back to $4.14. Only $4.13 so far but I have hope for tomorrow.
Here is an interesting thing to look at. SIRI closed at $4.12 on FRI. The July 15 $4.00 have a bid of 10 cents which is pathetic. But here is what is really interesting. The July 22, July 29 and Aug 5 calls ended the day with NO BID for the options. I can't say I have ever seen that before. Wonder what it means?
Okay, so let's get back to our theme that history started to repeat 2007. This week seven mutual funds told their investors that they would not be able to redeem their shares for months. The seven mutual funds shared the same characteristics, they were all invested in the London commercial real estate market. The idea of these funds was simple. Pool money, buy some commercial real estate in London, as in a bunch of high rise office buildings and watch your money grew by 15-20% a year due to the inherent leverage of debt financing. Simple except for one underlying flaw. Investors can pull their money on any day but it can take months, sometimes many months to sell a building. Of course, when things are going up, no one wants their money so things are going swimmingly. When things start going badly, everyone wants out but the fund can't sell and that is when your money becomes gated. Gated, that says you can't get you money back until we say so, so don't bother calling because the prospectus, which you didn't read said we could do this. This is not good.
Anyway, did you know that the same thing happened in early 2007 when the mortgage market started to crater. There was this firm call Bear Stearns and they had two funds invested in mortgage backed securities. People wanted to redeem but B S couldn't sell the mortgages so they gated withdrawals. Four months later Bear Stearns went BK. The question I have is why would anyone invest with a firm that had Bear in its name?
Buyer Beware. Anyway, if you don't see the similarity here it is. There was a mismatch between the availability of funds (daily availability) and the ability to raise funds by selling the assets (months if there is even a market at all). History repeats itself. Investors never learn.
But do you want to know what happened after Bear gated the funds? The overall market shrugged it off and rallied to a new all time high. But don't worry, that not likely to happen again because history doesn't repeat itself.
Mark Twain stated that history doesn't repeat itself but it does rhyme and it has become a staple of modern writers. While Twain was a fantastic story teller, The Duke thinks he may have this one wrong. History is always repeating itself. We are humans and constantly making the exact same mistakes over and over again. We just aren't smart enough to see that something has been repackaged but is basically the same as went before. You think Twain is right and The Duke is wrong? Okay, then why did Einstein say, the definition of insanity is doing the same thing over and over again and expecting a different result. Anyway, The Duke was a history major in college and firmly believes that history repeats itself ,and as you probably guessed, I am about to tell you 2016 is starting to look a lot like 2007.
So lets start with June auto sales. They were terrible even though you didn't see it. The estimate was for an increase of 5.4% on a YOY basis. The actual was a 2.5% and you are going to tell me that is good. You didn't do you homework. Lets look at the raw numbers. This June we sold 1,513,901 units vs last year's 1,476,675. Looks good until you realize that we had 26 selling days this year vs 25 last year. On a per day basis we sold 58,227 units a day vs. 59,067 last year or a drop of 840 units per day. Puts that 2.5% INCREASE into perspective.
Q2 was interesting in the auto business. None of the three months had the same number of selling days as in 2015 so comparisons were skewed. April and June had one more selling day while May had two less. But you know what that means, there were the same number of selling days in Q2 in both years. So lets look at the quarterly sales for both years. For 2016, they were 4,557,157 while in 2015 they totaled 4,566,716 or a drop of about 9,550 units. Interesting that no one noticed. Got any idea what was going on in 2007. Auto sales were setting new records until an unexpected slow down occurred mid year. Sales cratered in Q3.
So what does it all mean? The market seems to like double bottoms or as I like to call them W shaped patterns before it begins an up leg. If you look at a chart of the S&P it has two days straight down as four days straight up which form a PERFECT left side of a W. While we could go up a little more from here, the charts are telling us that there is a strong possibility that we will retest the 1892 low at some point in the next three or four weeks.
So what is the catalyst for the retest? In a word, DEBT. On Friday Puerto Rico defaulted on some general obligation bonds. The was a big deal. The GO debt was alleged protected by a constitutional guarantee that placed the interest payment first in line before anything else could be paid. Poof, the guarantee was scraped and default occurred. Over in Italy, PM Renzi tried to recapitalize the banks to the tune of $40B, but that failed because it violated EU rules. So they recapped one bank and got permission for a $150B loan guarantee to protect against bank runs. They also said the loan guarantees would never have to be used which begs the question of why you need them in the first place. Confused? It is simple. All the Italian banks are BK and once the depositors figure it out we will see Greek style lines and capital controls. The idea is to confuse everyone so no one figures it out.
Anyway, I betting that we get a right side of that W formation or a retest of the bottom within the next month so you might want to have some dry powder available.
As for SIRI, we are in the run up period to the CC and Frear is dusting off his speech from last Q...filling in the blanks with new numbers. You think we are headed into the $4.00 range. Maybe, but the CC is three weeks away and SIRI will follow the S&P. The only question is whether the CC will come before or after the Brexit echo wave. Right now they are on course to arrive about the same time, so plan accordingly.
So Brexit has come and gone but what happens next?
Before I answer that question let's review what happened in SIRI land and the market. On 6/23, the day before the vote SIRI had hit a high of 4.01 and closed at 4.00. After the vote that wrong footed the entire investment community, the market plunged about 900 points in two days and SIRI hit 3.74. Over the next four days SIRI rallied strongly and hit a high of $4.01 again on Friday and the market got within 1% of it 6/23 close. From a technical and Flabby perspective, we had a 100% retracement. 1 or 100% is a prime number for Flabby so all should be well in the market. The prevailing view is that Brexit, as far as the market goes, is behind us and we are poised to make another run at the all time high.
That may appear to be true in theory, but a look at the S&P suggests a different story is about to unfold. We all remember the Aug. 25 mini crash when the market opened down a 1000 points due to the Chinese devaluation of the yuan. We got as low 1867 that day before a strong rally wiped out the losses. But do remember that a little over a month later on Sept. 28, we revisited the lows at 1879 before we fully recovered.
Or what about this one? We all know that the market has rallied strongly since the 1810 bottom set on 2/11/16 to the present 2102, although the rally top was 2116. But did you know that the 1810 bottom was actually an echo bottom of one that took place a month earlier? Back on 1/20/16, we actually hit 1812, rallied only to retest the bottom three weeks later before the rally became durable.
So you don't understand everything I said but you kind of get the gist. JM pulled a fast one on you and has locked the price so it ain't going above $4.20 in the near term. So how do you make money now that you basically understand the rules of the game. You don't want to sell because you don't want to lose the tax advantage of LTG. Simple when SIRI is above $4.00, you short against the box for part of your position. Take the dummyofwallstreet who says he has 250K shares. If he had shorted 100K shares last week at 4.03 and covered FRI at 3.93 he would have $10,000 in cash in his account...a nice dividend while you are waiting for $5.00 The pros are doing this so why shouldn't you. Note the short is a separate position and does not effect your LTG in your long position. Check with your broker on the rules for shorting against the box. Or you can just complain and wait for $5.00.
Three weeks ago, I warned you that Brexit could unhinge the market. The latest poll on FRI giving it a 10 point lead did just that. I don't see the Fed raising this week due to Brexit but July is still a go. You need to understand Brexit has nothing to do with SIRI. If it occurs, the market could open 500 points down on the 24th. It will be a great buying opportunity. All of the shorts will be covering. You might as well join the party for a quick trade.
The Duke leaves on 6/18 to play in this year's WSOP. I will be coming back on 7/2 so maybe we get a post on 7/3. If we do, it might be later than usual.
Anyway, I know it is complex so let me simplify it for you. When the bonds were issued there was always a differential between the conversion price and the selling price of the stock and the bondholders were encouraged to short the stock in a riskless transaction....and they did.
So what is the deja vu all over again you ask. To begin with, the SIRI short interest for 5/31 was announced at 201.5M. Back on 2/12 it was 139.7M. That is up about 45%. Got any clue what is going on. Auto sales are flat but that isn't the big driver. So what is. The tracking stocks.
If you go back and read the article and debate between Deutsche Bank and Macquarie you will see that there is a 14% differential between the value of the tracking stock and the underlying security, SIRI. Now most of the LSXMA holders are institutions so they understand the game. They short SIRI against their LSXMA holdings and in effect capture the 14% differential in a risk free transaction. If SIRI goes down they cover the short at a profit. If SIRI goes up, their tracking stock should also go up and they would have no loss until the 14% differential was to widen. In effect, the tracking stock is acting like a convertible bond and is encouraging LSXMA to short SIRI, and they are. Deja Vu all over again and the stockholders don't have a clue what is happening. Deja vu squared.
So why is JM doing this you ask? Simple, the shorting keeps SIRI locked in that $3.80-4.05 range where he can just keep buying, or actually SIRI does the buying. Secondly, if the stock gets hammered in a market free fall, there are 201M shorts to cover and support the stock so he doesn't get a margin call. Pretty slick and no one understands what is going on which is even better.
I have actually alluded to this twice before but a recent conversation over on the LSXMA board quoted The Duke on the topic but couldn't figure out what I was saying. Deja vu all over again.
Let's go back in time to 2008 and I will show you the game that JM is playing with the stockholders. When SIRI and XM merged SIRI needed to pay off some debt that Mel mysterious forgot to refi and so he entered into a $500M convertible bond deal and supplied 274M shares for the bondholders to short against the stock.The bondholders got paid 7% per annum for the loan and could convert the shares at $1.87 at any time during the 5 years. The stock was trading at about $1.50 and given the price the bondholders had every incentive to short the stock, and they did. They shorted it into oblivion or almost oblivion. The key to understand what was going on was that as long as the stock was below 1.87, the bondholders could short with impunity because the bonds could be converted into stock, 534 shares for each $1,000 face value of the bonds they held. So if you were a bondholder, you knew you could short SIRI risk free. If you shorted and the stock went down, you could cover and make a profit. If you shorted and the stock went up and never went back down, you could hold on to the bonds, collect 7% each year and then convert the bonds to stock and pay off your short position. Basically, you were being paid to short and it was risk free. The stockholders were being hosed but they didn't understand what was going on.
Okay if you understand that, here is a different wrinkle. When the stock got above $1.87, the conversion price, the game got a little more complex. You could still short but if you made a mistake you lost out on further appreciation. Suppose you shorted at $2.40 and never got to cover. When the bonds were due, you took the stock and covered your short and got $2.40. If you didn't get caught, the stock was worth about $3.20 on the conversion date and you sold it to SIRI.
SIRI had another fantastic week if you just look at the analyst's comments. Last week I mentioned that James Ratcliffe had reiterated his BUY holding on SIRI with a price target of $5.00 that he has had for two and a half years. Then Wednesday, BOA chimed in with the same thing, SXM is a BUY with a $5.00 target and they reraised Ratcliffe by saying a dividend could be right around the corner.
Not to be outdone, two other banks chimed in on Thursday in a battle of the foreign banks. Deutsche Bank said buy the tracker for a 16% move from 32 to 37, while Macquarie said stick with SIRI because we are headed to $5.00 and JM might pay a bigger premium when he takes over the company. It is deja vu all over again. Everyone in the investment community loves the stock and tells you to buy.
So what did the stock do? It promptly feel below $4.00 for the forty second consecutive time. Deja vu all over again.
I saw Drunken on the Board saying SIRI has been consolidating again for the twentieth time and this was going to be a big summer. In November we will celebrate the three year anniversary of the Barron's cover which predicted $5.00 and Drunken will be saying any day now. Deja vu all over again.
The stock has pretty much stayed between $3.00 and $4.00 for two and a half years but everyone keeps buying the breakout story. Hope springs eternal in SIRI land.
Okay, so why hasn't the stock broken out above its historic high of $4.20. Deja vu all over again. It has just been repackaged in a new bright shiny package that investors don't understand or see. Maybe it is time to unwrap the package so that everyone can understand what is going on..and even make some money.
The problem for most investors is that they don't understand that JM's position and their hopes stand in juxtaposition to one another. You want the best price possible for your shares and his job is to keep the price as low as possible while he is acquiring the shares. So far he is winning, which means you are losing. The shares haven't gone anywhere since the first BB was announced in Dec. 2012. When the shares went past $4.00 the last time Frear told you SIRI cut back purchases. Why will it be any different this time?
I know that most of you don't know the difference between a buyout and a recapitalization so here are a few facts. When JM gets to 80% he can do a recapitalization. That what was done in Canada. Notice there was no vote. SIRI and its partners dictated the terms and the public shareholders were forced to take them. There is a real possibility that that could happen here and if you think you are getting $10.00 a share than you are really nuts.
Anyway, there is a more likely scenario that I have mentioned in the past that you should consider. SIRI has decommissioned the SIRI sats and will be operating with the XM sats. That is going to free up some spectrum that SIRI could sell to reduce its debt. That would be a good move. But what I think will happen is that the company will trade the spectrum to LMCA for its SIRI shares in a tax free exchange. That will leave you with 4B shares outstanding and I don't even want to guess the billions in debt. What do you think the shares will be worth then when half the spectrum is gone? You have another 2-3 years to watch the story unfold, so enjoy yourself.
May auto sales were worse than expected. Down 6%. Last year we sold 1,635,090 units for an average of 62,888 units a day. This year was 1,536,276 or 64,011 units a day. The Q has been flat for sales. On FRI, James Ratcliffe said SIRI will do 409K subs and 369K self pay subs in Q2. He reiterated his $5.00 call from two years ago. Hope springs eternal.
Let's take a look at where the BB will be on 6/30/17. At present the company has 5B shares outstanding and JM owns just under 3.2B. That means he will need to buy another BILLION shares to get to 80% control or so it would seem. But the number of shares outstanding is not static. The company is going to issue between 30-35M shares in the Canadian deal and then there are those pesky stock options. Most investors don't have a clue just how many options are outstanding but it is all detailed in the latest 10Q. as of 3/31/16 SIRI had 334M shares in outstanding stock options and 116M are eligible to be exercised this year. When you see the numbers, you realize the task involved in reducing the share count to 4B. The company not only has to purchase a billion shares but another 375M in shares that will be issued or exercised at some point. At current prices, you are looking at $4.00 x 1.375B equals 5.5B. The problem is that a year from now the company's debt load will be 7.8B and it will have only purchased about 50% of the 1.375B shares. Where does it go from there?
But things are even worse than they seem. When SIRI borrowed the latest Billion from the bond market it raised its leverage ratio to 3.7. The problem is that S&P has stated on numerous occasions that SIRI's bond rating is safe as long as its ratio is under 4. But what does that mean. The ratio is derived by dividing DEBT BY EBITDA. We know what EBITDA is projected to be...1.75B. What that means is when SIRI's debt hits 7B or about 900m more than it is now, the company will be at a 4x ratio. At that point things become dicey when it comes to adding more debt without S&P acting to cut the bond rating.
The other problem is that every time the PPS goes up, the company buys back fewer shares because the debt load would even be higher. So the answer to GP's question is simple. SIRI can't speed up the BB because it is running out of leverage and you show be hoping for a lower PPS rather than a higher one.
While I was attending Whitney's graduation, SIRI borrowed another Billion dollars to pay off its revolver and continue BB4. The move was generally greeted with enthusiasm from investors who may not understand its implications. In light of the move gpertr asked me this week why doesn't JM just speed up the BB so he can sell out at $15.00. Most investors are thinking about the pot of gold at the BB's end, but maybe they don't understand the difficulty in getting to the end.
So let's take a look at SIRI's debt situation and a household budget for the company beginning with Q3 on 7/1/16. At the end of last Q (Q1), SIRI had 5.7B in debt. The new debt will pay off $600M in revolving debt but leave the company with 6.1B in total debt. SIRI had 100M in cash on its balance sheet at the end of Q1 and the new debt added 400M in cash. But don't celebrate too quickly. The 2Q BB will use up about 275M of the cash leaving SIRI with about 225M of cash on 7/1/16. You need to remember that SIRI spends 90M more each month than its FCF to buy back its shares.
So let's look at SIRI's negative cash flow for the twelve months starting 7/1/16. First, lets assume the BB continues at its present pace. That means SIRI will need to borrow a Billion dollars from the revolver to fund it. Then you have about 200M for the Canadian deal and 600M for the three replacement sats it will be putting into orbit. That is 1.8B over and above FCF which will totally use up the 1.75B revolver. At that point SIRI's debt will be 7.85B and Siri will need to go back to the bond market.
It is all a matter of DOLLARS and CENTS (SENSE). JM needs to buy about 1 BILLION shares to get the 80% control he would need to take over the company without a vote. The cost would be about 4 BILLION dollars but the company doesn't have the capacity to borrow that much after it borrowed a BILLION to pay off the revolver and fund the Canadian take over.
He has no choice but to follow this strategy that will take years to execute. While the strategy is playing out SIRI will issue 30M shares to Canadian holders and have 150M shares exercised in stock options so the total cost is 5 BILLION for the takeover. In the meantime, nothing happens and people move on to greener pastures.
The question that none of you asks is what will you get when JM takes over the company? Probably a small premium but nothing like what you imagine. You will get a deal like Canada, cash representing a small premium or shares in the tracker with the hope they will appreciate...some day.
JM thinks he will live forever. The question is can you wait and what will you get?
That doesn't mean that some people haven't already figured this out. Let's take a look at the SIRI SI. On 3/31 it stood at 163M shares. This had been a pretty stable number for about six months. On 4/15 it bumped up to 171M, hit 185M on 4/29 and was 195M on 5/13. Basically, we had a 25% increase in the SI in a 45 day period. It is also fair to assume that the 32M newly shorted shares are professionals unless Roger hit the Powerball.
There is a lot of talk out there about the market hitting a new high. It is possible and I'm on record for saying it will happen before the great plunge.
As for SIRI, the breakout to 4.02 shows that if the world holds together for a few more weeks we could see a short term move to the 4.14 level I predicted after the CC. There is no guarantee we will see this level but what I can guarantee you is that the $4.00 will be a short term level that will usher in massive short selling. Ultimately, this will lead to much lower prices in SIRI.
Blame it on Yellen, I'm just the messenger. Besides, I have a barbeque to host this afternoon. Enjoy the rest of your holiday.
The problem is two fold. People leased those cars back in 2013 and prices for the same 2016 models are up 10% during those three years. Throw in the fact that those zero financing deals are a thing of the past and new car sales are about to take a real downturn. The words sticker shock are about to rear their ugly head in the world of leases. But don't worry, the industry has a fix for lessee's who can't afford that new car smell. Since the car they now drive has depreciated 50%, they can buy it a second time, spread out the payments over 36 months and have about the same payment as when the car was new. This will reduce the glut of used cars on the market and halt the downward pressure on used car prices. It makes sense for the dealer and the buyer. As interest rates continue to rise, and Yellen seems intent on more rate hikes, the term can be extended out to 48 or 60 months to keep it within reason.
So many leases are we talking about. In 2013 about 25% of cars that were "sold" were really just rental leases. 15M cars were sold that year so put the lease fleet at 3.7M give or take. If just 10% are priced out of the market, things will get dicey pretty quickly.
This doesn't mean SIRI numbers will collapse over night. The company has 5.4M subs on trial and 24.6M self pay subs. SIRI can live off of flat sales for a while. The overall sub numbers will continue to grow, but at a slower rate than last year's 2.2M. SIRI guided to 1.6M so part of the slow down is already baked into the cake. The self pays will grow for a while because with 5.4M people that have to make a decision on the service and a 38% conversion rate the increases are built in for a couple of quarters.
The problem comes when new car sales decline in real numbers for a quarter. The subsidized subs begin to decline and the self pay follow suit. We should expect to see new car sales to be negative on a YOY basis by Sept. and that is when the PPS is likely to take a hit.
The estimates for May auto sales are out and they aren't pretty. Kelley Blue Book says sales on a YOY basis they will be down 3%. True Car says 4% while LMC Automotive goes the furthest and says 5.7%. But don't worry we are told, the drop off is all statistical. You see, May has two less selling days and if you look at the number of cars sold on a daily basis sales will be flat with 2015.
Funny, back in March when there were two selling days no one mentioned that the increase in sales was due only to the extra two selling days and that the YOY sales per day were flat. Same thing happened in April when there was one extra day and the sales per day were slightly down. No one mentioned it, except for The Duke. Now that sales will be down in May, everyone is telling you to ignore the gross number and look at the daily rate. Interesting how the story changes.
If that was the end of the story that would be bad enough, but that isn't the end of the story. Kelley Blue Book cut its 2016 sales forecast by 100,000 units only to be one upped by LMC Automotive that cut its forecast by 200,000 units. To understand what really happened, you have to look beyond the numbers in the press release. LMC automotive had predicted that auto sales would grow by 400,000 this year. Now the growth is down to 200,000 for the year. Sounds good until you realize that auto sales were up 185.000 through April 30.
So the real way to look at the cut is that LMC is saying that auto sales will be flat for the rest of the year.
The yearly changes were made a week ago but now even they are worthless.
Everything changed on FRI when Yellen made clear that it was appropriate to begin raising interest rates in either June or July. I told you earlier that the flood of leased cars would be hitting the dealer's lots this summer. It is about to start and the lessees are in for a shock. They are expecting to return the car and lease a new one. Many are in for a rude awakening.
Liberty owns about 3.2B shares. SIRI has 5B outstanding shares. That means SIRI would have to buy back another BILLION shares for Liberty to get to 80%. That would be the case if SIRI wasn't issuing new shares but it will for SXM deal and employee stock options. So figure it will take 1.1 billion shares to get to 80%. At the current rate that will take two years.
The problem is SIRI will run out of borrowed funds and have to scale back purchases. So figure about 3/4 years if all goes well. Enjoy the wait.
It was that comment that caused some of the sell off that we saw this week. There is no such thing as free press over in China so the appearance of the article on the front page was interpreted as a warning that the PBOC was rethinking its policy of flooding the market with cheap money to save its debt ridden industries from default. If you remember, markets around the world have rallied because of QE and it has been assumed that the PBOC would keep the party going through the end of the year. If they have changed their tune, there is nothing underpinning stock prices and so therefore we have a massive air pocket waiting to be filled.
Your question should be, okay Duke, but we have been this way for a while and nothing bad has happened so why will it happen this time. Actually, bad things did happen but the market recovered, so everyone has forgotten. We had the 1000 point drop in Aug and the 11% sell off in Jan. and Feb. of this year. Just a warm up for what is coming.
Here are a couple of things that occurred in financial markets in banks/credit. Italian banks dropped another 2.9% and banks on the Hang Seng were down another 2.5%. Lending Club, an incredible stupid idea, dropped 50% this week when its CEO resigned amid allegations that the credit quality of a 22M loan package had been misrepresented. Shades of what we saw in the subprime mortgage blowup back in 2007/08. Big Short 2?
The world likes to blame financial meltdowns on specific events even though the foundation for the collapse has been months in the making. Here are two possibilities for you to follow. The Brexit vote on 6/23 and a possible Yuan devaluation some weekend as the PBOC tries to help out its failing exporters. If either happens, the air pocket will get filled quickly.
The Duke will be in New Haven next weekend attending Whitney's graduation from Yale Medical School so I will see you in two weeks.