MARKET ACITIVITY/TRADING NOTES FOR DAY ENDING FRIDAY APRIL 24, 1998 (3)
MARKET WATCH, Con't
Those Cozy Conference Calls With A High-Flying Stock Pick Can Go So Well
Report On Business Magazine
My index and middle finger were poised over the "Play" and "Record" buttons of our tape recorder as the conference operator began, "Hello, I'm Susan and I'm your conference operator today.." I looked up at my partner, George, and my associate, Pete. George was nursing a freshly poured cup of coffee, and Pete his spreadsheet and notes on Newcrown, the big financial services conglomerate about to start its conference call. We were all hunched over the corner table in my office, the tape recorder a weird kind of centrepiece, and there was palpable tension in the room. My glance caught George's eyes and held them: Our pension funds held $200 million of Newcrown stock, and this call was crucial.
"You will be on 'listen-only' mode until the question period. If you wish to ask a question, push 'pound one one' on your telephones, and you will be queued.." Newcrown had been on a tear lately: a big equity issue, several acquisitions, increased top-line growth, all the brokerage analysts writing glowing reports to position their firms for future underwritings. That's where the trouble began: All these so-called research reports stated that Newcrown would earn $1 a share in 1997, $2 a share in 1998, $3 a share in 1999, and so on; but the stock had recently stopped going up.
"Now we are turning the call over to Mr. Jones, president and CEO of Newcrown Financial Services." I pushed "Play" and "Record" and sat back in my chair. There was a boundary between sincere hype and disingenuous promotion which the CEO never crossed. He had great control of the dynamics with his youthful baritone, stepping up to such crescendos of adjectives as "exceptional and forward looking" that his listeners didn't even register on the nouns. Our young analyst, Pete, was nodding his head with the certainty of one confirmed in all his projections. The CEO ended his comments by stating, "Banks are obsolete!"
Next, Newcrown's CFO handled the financials. Last year's spectacular earnings growth, cost reductions fuelling margin expansion, a major acquisition in the United States. As he droned on, it reminded me of those school assemblies so long ago; the scratchy distant monologues that lost everyone's interest. So I took the long ago escape of staring blankly out the window. A small airplane was lazily circling the bank towers, towing some message followed by a telephone number. Maybe another conference call, I daydreamed.
The tone of the call began to deteriorate when the young CFO stated pointblank, "Remember, the way Newcrown does its business, there is no risk. We perfectly match our assets and liabilities.."
"Cripes, David, do we have a $200-million position in this ramp? This guy talks like IACC in the '60s!"
"Calm down, George. Remember we have a $40-million profit on this position, so far. If they don't blow this call, they might get some U.S. analysts to cover the stock, and it really is under-owned in New York." Pete walked to the other room to check the stock quote and shouted, "She's up one-and-a-quarter points."
The first four or five calls were from Canadian brokerage analysts, all starting, "Congratulations on your excellent results." and continuing to slo-pitch questions confirming management's earlier projections of unstoppable growth. Pete was beaming ear to ear, fondling his spreadsheet like a Catholic fingering the rosary. I turned to him, "Pete, when you built this model of Newcrown's growth, did you talk to these analysts?" Pete looked back defiantly, "Of course, and they checked the projections with the CFO. So these are really his numbers; like you said, you gotta go to the source to get the purest water. I tell you this $3 eps forecast is a sure thing." George exhaled, "Oh Cripes," in a soft rasp.
"Now for the next question. Please state your name and company."
"John Poland, RBC DS."
"David, now the sniper is coming on." George looked over at me with his eyebrows raised a good three inches over their usual position. The sniper was his nickname for one of the arbs at one of the bank owned dealers, someone whose short-selling usually meant trouble for our positions.
"I have a few minor accounting questions. Why aren't you adjusting your deferred tax rate after your latest acquisition - how will you be able to shelter that income? How can you say that your EBITDA as a percentage-of-sales margin will continue at 1997 levels when you also say the latest acquisition fundamentally changes your business to a more residual risk, less margin business? Thirdly, your market cap has increased in the past two years from $1 billion to $6 billion, and you have reduced financial leverage and increased your tax rate. To maintain your previous growth rate in pretax operating profit, you will have to boost your margins by 500 basis points. How do you intend to do this?"
This was serious. George and I had learned long ago that the way to turn street sentiment on a stock was to change the questions being asked. The sniper was destroying this stock by casting doubt on its accounting, and he was doing it while two dozen impressionable analysts listened in. It didn't take much imagination to guess the change in tone of the next week's morning comments, research briefs and valuation notes. Even the seasoned money managers would turn negative.
The tone of the CFO's voice had lost its earlier cockiness; he sounded like a young boxer looks in Round 3 of a fight he's losing, each accounting question hitting him squarely on the jaw or in the solar plexus. He was bleeding - his voice limply raising the excuse of generally accepted accounting principles or what his auditors had told him. Worse, he was speaking without enthusiasm. This call would cost us at least $5 a share in stock price. George had gone to check the stock quote: "Newcrown stock has reversed; it's down a half-point. That's almost two points off the earlier high!"
I hit #11 on the telephone. "Our next question is from, please state your name and company."
"David McAllister, Panegyric Pension Planning. Good morning, I just wanted to ask Mr. Jones about recent mergers and acquisitions in his industry, and what valuation that places on Newcrown stock." The CEO stepped in and spoke very smoothly about some high-ball U.S. deals that made his stock look cheap. He was good, cutting and pasting price-to-sales multiples from deals with lower sales, but higher margins, than Newcrown, and price-to-earnings multiples from deals with higher sales and lower earnings than his company. George and I were grinning with relief: We knew better, but the CEO almost convinced us his stock was 50% underpriced! George pushed the mute button on our speaker phone: "I'd love to be in the room right now with the DS arb guys; they must be crying at this upbeat BS. It'll cost them five points on their short, ha ha!"
"Unless there are further questions, this will end this morning's conference call." Oh, a repeat question from.rbc ds." The sniper spoke in a cold, unemotional tone. "Mr. Jones, is it true that your company just purchased a Falcon jet aircraft, and can you tell us if you paid a list price of $17 million U.S.?"
George, Pete and I all let out a "Noooooohhh" as we waited, and waited, and waited for the CEO to respond. He spoke about an octave lower, with all the dynamics beaten out; his voice was flatter than warm beer on a saucer. "Uhhh, that's true, Mr. Poland, uhh, our managers, uh, that is, your company, uhhh, felt that it was time, uh, we got an excellent deal from, uh.."
I swept Pete's financial model off the table in front of me to make space for my head, and beat the table in rhythm to the CEO's hesitations. Beaten beaten, beaten.
Scary Financial Scenario Gets More Notice
Associated Press
Forget the nirvana economy. With a stock market surging into the stratosphere and merger mania overtaking the banking system, some people envision a doomsday scenario. They believe the United States has a bad case of the "bubbles" - financial froth that eventually will lead to a crackdown by the Federal Reserve and a severe recession.
A recent issue of the respected The Economist magazine offered a cover story entitled America Bubbles Over, in which it contended that the stock market's 30 per cent increase in just the last year, the rash of multibillion-dollar bank mergers and rising real estate prices all point to an economy exhibiting dangerous signs of excess. "Just as champagne tastes wonderful until the bubbles go to your head, so financial bubbles tend to create nasty economic hangovers," the British magazine wrote.
It argued that the U.S. episode would likely end with the central bank having to calm the speculative fever by jacking up interest rates, possibly pushing them so high as to cause a recession.
Some American economists agree there is cause for concern.
"We do seem to be in a classic speculative boom," said Robert Dederick, economist at Northern Trust Co. in Chicago. "There are signs that the market is pulling away from what have been good fundamentals and extrapolating them into the future in an unrealistic way."
The underlying U.S. economy has been remarkable. The current economic expansion has just entered its eighth year, the third longest period without a downturn in history. What is even more remarkable, even though unemployment has fallen to levels not seen since the late 1960s, inflation pressures are falling, not rising.
All the good news has led some to proclaim that the economy has entered a new era in which rising productivity is letting the economy run at a faster speed without triggering inflation. But even advocates of this theory worry that investors have gotten too bullish about future prospects.
Many analysts believe the stock market is overvalued and due for a fall and American manufacturers have yet to feel the full brunt of the Asian economic troubles. But neither event is expected to do more than slow U.S. economic growth, causing only a slight rise in unemployment.
"My favorite advice is 'Don't worry. Be happy,"' said David Wyss, senior financial economist at Standard & Poor's DRI. "Is this going to last forever?
Of course not. But neither is the end imminent."
Concerns about an overvalued stock market did help push stocks lower Friday. The Dow Jones industrial average, which climbed to a new all-time high of 9,184.94 Tuesday, fell 78.71 Friday to close at 9,064.62.
So far, the Federal Reserve has been on the sidelines, watching to see what impact Asia will have on the U.S. economy. Federal Reserve Chairman Alan Greenspan is not even voicing worries about the stock market, even though it stands 40 per cent higher than it did in December 1996 when he uttered his famous worry about "irrational exuberance."
Many economists are betting the Fed will choose to stand pat at least until the full impact of the Asian crisis is better known. The new fear is that Japan, the world's second largest economy, is fast slipping into recession, a development that could destabilize the global economy.
To jump-start its economy, the Japanese government announced details of a $127 billion economic stimulus package Friday. The U.S. administration gave a guarded reaction, saying the real test will be how fast Japan implements the plan and whether it takes further needed steps to deregulate its economy.
Many observers believe Greenspan wants to wait to see how events in Asia affect the U.S. economy while a Fed minority is pushing for quicker action.
"Greenspan is holding off the charge, saying we need more data before we can move," said David Jones, chief economist at Aubrey G. Lanston & Co.
But if inflation starts to creep higher by this summer, Fed rate hikes can be expected to follow, a development financial markets are unlikely to appreciate.
Analysts remember that the last Fed increase, a tiny quarter-point move in March 1997, was enough to push the market down 10 per cent during a two-month period.
"The market is more overvalued now than it was a year ago," said Sung Won Sohn, chief economist at Norwest Corp. in Minneapolis. "If interest rates start going up, it could have a pronounced effect on the stock market." |
