Contrarian Chronicles, Bill Fleckenstein... ... ... ... ... .....
01-24-05
Behind the numbers, Fannie Mae, GM are struggling
They may beat the Street estimates. But their earnings reports -- and those of many other companies last week -- give investors plenty of reasons to worry.
When companies implode slowly, folks often erroneously conclude that all is well. When Enron came unstuck, it unraveled slowly at first, before dropping from about $38 to $4 in two weeks.
To my eyes, Fannie Mae (FNM, news, msgs) is a train wreck moving in slow motion when -- in this modern world of finance, and given Fannie's balance sheet -- one would think the wreck would occur at the speed of light.
No sane person can now draw any other conclusion about Fannie Mae than that its business is forever changed, from what is believed to have been and what it was.
As Jim Grant said in the most recent issue of "Grant's Interest Rate Observer," "Before the scandal, Fannie's business model was one part simplicity, another part privilege and a third part audacity: Borrow at a government-advantaged rate; invest at a slightly higher rate. Leverage the balance sheet as no private enterprise could. Grow and grow. Deliver predictable, stair-step earnings growth."
That pretty much sums up what Fannie Mae's business plan used to be. Any time it was threatened, it invoked the sacred word, "homeownership." That got anyone hassling the mortgage lender off its back.
That, of course, has all changed. The Office of Federal Housing Enterprise Oversight has questioned Fannie's earnings calculations, and Fannie has recently been forced to raise capital in a fairly expensive fashion, via a preferred offering. It has cut its dividend in half -- from 52 cents a quarter to 26 cents. The stock is off more than 9.7% so far in January and 25.8% from its all-time high in December 2000.
It is no longer business as it once was for Fannie, the second-largest U.S. company in terms of assets. That change will have far-reaching ramifications which, to my mind, have not yet been felt.
Four-wheel financing folly
Turning to my other favorite speculative financier, that being General Motors (GM, news, msgs), I shake my head every time I think about their bonds trading at 400 basis points over Treasurys when the automaker willingly lends money to anybody, upside-down or credit-worthy, for zero percent. Likewise, General Motors (via General Motors Acceptance Corp.) is the company behind Ditech.com, an organization that prides itself on basically lending any amount of money to anybody.
In any case, GM announced earnings last Wednesday, and, gee whiz, it beat the number. I think the fact that the stock headed south so quickly the next day (The stock fell 1.25% on Thursday) was indicative of trouble. (Of course, I am biased on that subject.) I certainly think that with GM and Fannie Mae coming under pressure, there's an ill wind blowing for housing -- and that's without even discussing all the other financial intermediaries like Capital One Financial (COF, news, msgs), which blew up Wednesday evening.
When a surge isn't a surge
A story moved last Tuesday on Bloomberg about an "unexpected surge" in IBM's (IBM, news, msgs) backlog. Some online dead fish trumpeted the IBM story as well. Obviously, they didn't know enough to understand that the $12.7 billion in new bookings for IBM's services business were less than the $14 billion to $15 billion that had been rumored. The number was less than last year's $17 billion, the almost-$19 billion in 2002 and the $15 billion in 2001 -- in the teeth of the tech bust.
So, Big Blue's backlog for services was down, and its bookings were the lowest in three years. Yet, everyone was crowing about IBM because it was able to win at the silly game of beat-the-number. Well, nearly everybody wins at beat-the-number. Even GM managed to win at beat-the-number as it unraveled. Fannie Mae won at beat-the-number for years, but we now know it's been cooking the books.
Chronic winners -- or sinners?
Ladies and gentlemen, any company that wins at beat-the-number on a regular basis most likely made it up. Multibillion-dollar businesses are far too complicated to be able to hit a number within a penny, time and time again. Could any of you project for me what your checkbook balance will be at the end of a month?
Most of you don't have that many moving parts, and you know with some degree of certainty what you'll spend. Yet, you can't predict to the penny what your checkbook will have in it. Companies can't predict what they're going to earn that precisely, either. The fact that they're doing it means they're basically playing games.
For years, I have been saying that IBM is in the stock-promotion business, not the computer business. It keeps selling off pieces of itself. As it does that, it finds some piece of the former business that it manages to book as a contra expense. In fact, 10% of its earnings reported last week came from an expense reduction on the intellectual-property and custom-development line item. Almost 10% of earnings in 2003 and 2004 came from there as well. Now IBM is selling off its PC business to Lenovo Group. I don't know how many more businesses IBM can shed, allowing it to pull more rabbits out of the hat.
One of these days, the business is going to totally unwind. Perhaps we'll find out that IBM's accrual rates are not as they should have been, and it will have an EDS-like moment. Obviously, this is just conjecture on my part, but I've seen many data points along the way that have led me to this conclusion. Only time will tell for sure.
Tech's sagging saga, continued
As for some other tech companies that reported last Tuesday night, most -- but not all -- won at beat-the-number. However, it is the words that accompanied the numbers that should spook investors. Advanced Micro Devices (AMD, news, msgs), Motorola (MOT, news, msgs), Teradyne (TER, news, msgs), ASML Holding (ASML, news, msgs) and Lucent Technologies (LU, news, msgs) were disappointing. Maybe there's room for debate in Juniper Networks (JNPR, news, msgs) and Linear Technology (LLTC, news, msgs).
Yahoo! (YHOO, news, msgs) seemed to be the only one without too many warts. But Yahoo!'s accounting is from the school of "before depreciation, before amortization," etc. With Yahoo!, there's so much left to the imagination that who knows what it's really earning?
I would like to point out that in the semiconductor-equipment business (an area where I've been rather vocal), folks had gotten excited two weeks ago because of what Intel (INTC, news, msgs) said. But last Tuesday night, ASML Holding, which stands at the front of the semiconductor-capital-equipment food chain (because its equipment is used at the start of the semiconductor-manufacturing process), basically announced that it had no orders in November. At year's end, ASML's backlog stood at 119 systems, versus 162 in September. For the quarter, people were looking for orders of about 53 systems, and they came in at 19.
At the back end of the food chain, testing company Teradyne was a horror show as well. Based on its comments, and on what contract manufacturers have had to say, it's pretty apparent that excess inventory is everywhere.
The difference between the companies that reported bad news, versus the ones that just managed to make the number (even though some companies that made the number had already reduced the number) boils down to one issue:
Companies such as Intel that were able to sell into the retail channel or into products sold into the retail channel, did OK. The companies that are dependent on selling out from the retail channel, i.e., which need real product sales, like Motorola haven't done so well. However, the companies that did well this quarter (benefiting from sell-in) will be penalized next quarter -- when the fact that the stuff sold in didn't sell out comes back to bite them, in the form of reduced orders.
The year of the bear
Tech speculators were dealt a serious blow Wednesday night when eBay (EBAY, news, msgs) lost at beat-the-number and Qualcomm (QCOM, news, msgs) disappointed with its second-quarter profit forecast. Add Research in Motion (RIMM, news, msgs) and that makes three members of the GERQY list (championed by Jim Cramer) that have now stumbled. (GERQY stands for: Google (GOOG, news, msgs), eBay, Research in Motion, Qualcomm and Yahoo.)
With speculation, speculative financiers, chip stocks and stocks generically under pressure, 2005 is off to a bad start. Before it's over, as I have been warning, I expect things to get far worse.
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