Boyd and Interoil

Roddy Boyd, in his blog, The Financial Investigator, has a fascinating post on The Interoil Math. Interoil is an oil and gas producer that, Boyd says, "recently raised cash at exorbitant rates and appears to be internally valuing its assets way below what the market appears to think they are worth."

So, on such revelations, its stock price should be tanking, right?

Ummm ... no. The stock price rose sharply in the middle of the day Wednesday, September 15, and held level at close to $64 a share through Thursday and Friday, and resumed moving north on Monday.

"To be sure," Boyd continues, "the bull’s case is both elegant and obvious: If there is oil and natural gas is in Papua New Guinea, and in the volumes suggested on the company’s properties, shareholders are in for an instant windfall to the tune of several dozen points worth of price appreciation."

And if my car had a propeller, it would be The Spirit of St Louis.

Provable reserves as I noted last November are hard to come by.Separately: any company that found them in Papua New Guinea would still have to be willing and able to spend the money to exploit them. Yet Interoil is cash strapped -- sufficiently strapped to need to pay those card-card-like interest rates we mentioned above.

Interoil will naturally tempt short selling. Of course, if you do go down that road, you take enormous chances, even if your underlying case is strong. Such intriguing recent books as CONFIDENCE GAME, whatever else they do, make this clear. I don't recommend shorting -- indeed, I don't recommend anything at all. [Except this: for roughly 99% of investors who have an interest in the equity markets, the best course is a simple passively managed fund, tracking some broad-based index.] Still, Interoil is the sort of spectacle that makes one wish there was more shorting activity in the financial world than there is. The number of nest eggs that have to be sacrificed to prove the prophetic powers of P.T. Barnum is unnecessarily high.

Lehman's Problems, Continued

I'm still mining the Examiner's Report that I discussed yesterday, looking for the good nuggets.

I found this: On page 480 of the second pdf in the series, the Examiner is discussing Lehman's efforts to sell itself to Warren Buffett. Fuld and Buffett spoke on Friday, March 28, 2008.

"They discussed Buffett investing at least $2 billion in Lehman. Two items immediately concerned Buffett during his conversation with Fuld. First, Buffett wanted Lehman executives to buy under the same terms as Buffett. Fuld explained to the Examiner that he was reluctant to require a significant buy-in from Lehman executives, because they already received much of their compensation in stock. However, Buffett took it as a negative that Lehman executives were not willing to participate in a significant way. Second, Buffett did not like that Fuld complained about short sellers. Buffett thought that blaming short sellers was indicative of a failure to admit one's own problems."

Buffett was of course wise in this. And the short sellers were right to believe that Lehman was over-valued as Einhorn explained in May 2008.

The vulture doesn't kill. The vulture feeds on the flesh of the dead. And, in so doing, said vulture performs a service. Though he is led to perform that service by his regard for his own self-interest, it is a genuine service. Bring out your old Adam Smith neckties!

Short-selling Roundtable

The SEC held another one of its "roundtables" last week.

This one, on Tuesday, May 5, concerned short sales and the best way to check a bear raid. The SEC under its new leadership seems to have made up its mind that one of two checks ought to be in place -- either a trae-by-trade uptick rule or a day by day circuit breaker rule. Maybe both. It appears that the roundtable was convened to assist it in making up its mind among those alternatives.

The circuit breaker proposal would mean, specifically, that if a particular stock declined by more than 10% in a given day, something would happen to staunch the bleeding. Under the most restrictive of the three variants of the circuit-breaker proposal, such a decline would simply result in an end to the trading in that stock for the remainder thereof.

One of the panelists was James Angel, an associate professor at the McDonough School of Business at Georgetown University, and the co-author (with Douglas McCabe, of "The Business Ethocs of Selling Short and of Naked Short Selling," which you can find here.

TCI Goes Short on Japan

I've written of TCI before here. In a post last May for example, I mentioned TCI's proxy contest among shareholders of the Japanese power company J-Power. The management prevailed against TCI in that contest, largely because Japan's government came to their aid. TCI sold its stake in J-Power in October, taking a US$130 million loss.

Now I read that TCI has changed its tack as to its Japanese positions. In order to be a corporate activist, an investor essentially has to be long -- has to own voting equity. But TCI has switched (according to a recent Bloomberg story) to a predominantly short strategy in regards Japan.

TCI has about US$1.2 billion in cumulative short positions in 13 Japanese stocks, including some of that country's biggest names: Toshiba Corp.; Sharp Corp.; Mizuho Financial; Sony Corp., and so forth.

Its short position in Toshiba was worth 39.5 billion yen (US$396 million) at the close of business Wednesday, April 1.

In October of last year the government imposed new requirements on short selling, including disclosure rules, so this data is now available through the Tokyo Stock Exchange's website, though as I say I've lazily taken it from Bloomberg's story.

Here are links, first to Bloomberg;

then to the TSE's English-language page.

Gary Ackerman's bill

On Thursday, Rep. Gary Ackerman introduced into the House of Representatives a bill (HR 302) that would require the SEC to reinstate the uptick rule.

This bears watching. I don't think the Obama administration will give it high priority, simply because they'll have too much else on their plate, but if it should strike a chord the incoming administration surely won't get on the opposite side.

Ackerman, a Democrat, represents New York's fifth congressional district -- the northwestern corner of Nassau County and the northeastern chunk of Queens.

His bill has six co-sponsors. It has been referred to the Financial Services Committee, chaired by Barney Frank.

Timminco Again

The last time I wrote in this blog about Timminco, the Toronto, Canada-based silicon-processing concern, was late August of this year. The stock price was around C$15 at that time.

The price has slipped to $2.75 since.

The reason for returning to the subject, though, isn't that slide in itself. It is morethat the company has removed a positive report on its technology from its website. The report was called the "Photon Consulting Operational Review," and it purported to review Timminco's production of materials used in the manufacture of low-cost solar cells.

The review came under fire as soon as it was issued, back in the spring, i.e. back when the stock price was C$24.90! Now Timminco seems to be admitting that its critics had a point. In corporate-speak, it "believes that some of the material factors or assumptions originally used to develop the forward-looking information in the Photon Report, including in respect of revenues, production volumes and costs, may no longer be valid."

Here, as in many other instances, the short sellers of a stock aren't nasty manipulators throwing dirt at a well run company. There has surely been short interest in Timminco, but the shorts in these situations come out looking like detectives who ferreted out valuable information, thereby making themselves a profit while performing a public service.

Don't you love it when things work out?

Porsche and VW

VW shares shot up on the Deutsche Börse over the last two days in what looks like a classic "short squeeze." I'll take this as an opportunity to go into full-pedantry mode and explain what a short squeeze is. Those of you who already know, or who neither know nor care to learn, are of course free to click yourselves elsewhere at this point!

The price of a share of equity in Europe's largest auto manufacturer increased by 147% Monday, and is up again, though somewhat less dramatically, today.

Here's a closely-related fact: as of last Thursday, 12.9% of VW's shares were on loan to short sellers.

A short squeeze in an uncomfortable event in the life of a short seller. Specifically, it is what happens when a substantial share of a company's stock is out on loan for purposes of a short play, and the stock's price unexpectedly starts to rise. The short sellers need to cover, and they all may decide they need to cover at the same time, because they now expect the stock price to continue rising and they have to cut their losses. So they head for the same exit door at the same time, shouting "buy, buy, buy!"

This of course makes the price of passage through that exit increasingly expensive.

That, then, is what is going on with VW. Over the weekend, Porsche unexpectedly disclosed that through the use of derivatives it has recently accumulated a 74.1% stake in VW, up from 34%. The state of lower Saxony owns 20.1% This means that there is a "free float" of only 5.8% of VW's capitalization. It also means, as a matter of arithmetical necessity, that some of those shares on loan must actually be the property of Porsche or Saxony, though the short sellers presumably obtained them through the services of a prime broker.

It didn't take long for short sellers to do the math and decide that the exit door was shockingly narrow.

VW is one of the shares on which the Teutonic DJIA, the Dax index, is built. So Dax has shot up along with VW. This morning the Financial Times quotes one analyst thus: "This is a special situation and I think it will go on as long as Deutsche Börse doesn't make a decision regarding these extreme movements in VW shares."

Shorting Financial Stocks: Back in Town

In the middle of September, the SEC issued an emergency order, originally designed only to last two weeks, that banned all short-selling in the stock of financial services companies.

All short selling. This wasn't an order aimed at the "abuse" of short selling in one way or another. It prohibited the practice as a whole.

Two weeks later, the SEC extended that order until October 17 -- the end of the full 30 day period allowed for its "emergency" decrees under statute.

Fortunately (for those of us who think the ban was a stupid idea in the first place) the extension contained something of a loophole. The ban was re-jiggered to end at the earlier of two events: the expiration of the 30 days, or the passage of three business days from enactment of the Wall Street bail-out bill.

That bill -- another really stupid idea, but let that pass for now -- became law with the President's signature on Friday. Thus, the brief backbencher's revolt that had broken out Monday proved a cheering but brief incident.

Anyway, with the bail-out bill signed, the emergency order will expire Wednesday. Authentic price discovery is back. A small silver lining to the cloud of dumb political and bad financial news in recent days and weeks.

US equity prices

There's been an inordinate amount of punditry in recent days linking the rise and fall of US equity prices to the prospects of Wall Street bailout legislation in Congress.

I was just listening to such talk on morning television, along with admonitions that "bailout" isn't the right word. It's a "rescue." Well ... excuse me.

Either way, I'd like to interject some skepticism about that link. The market didn't rise Friday, I submit, because it had decided that the "Paulson plan" will pass and prove wonderful. The market rose Friday because the SEC banned short selling on a wide range of stocks.

If you arbitrarily exclude a certain class of sellers, then you've jiggered the prices in favor of a rise. How complicated a concept is that?

Likewise, I submit, the market didn't fall Monday because the market has suddenly become worried Congress won't pass the bill after all.

More likely, it fell because evidence accumulated over the weekend that the SEC isn't all that serious about the short sale ban, and that it won't last. That, by the way, is very good news and we should welcome Monday's decline as part of the natural equilibrium-seeking process for unjiggered prices.

On the broader point, Gordon Crovitz had a fascinating op-ed piece in yesterday's WSJ, under the headline "Information Haves and Have-Nots."

The money quote. "There are now about half as many Wall Street analysts as in 2000. Former New York Attorney General Eliot Spitzer eviscerated the profession with $1.4 billiuon in settlements and a new mandate for how the industry would be structured, which made the analysts uneconomical....The now-former senior executives at Bear Stearns, Lehman and Merrill must wish they had been able to retain all those star banking analysts."

Another Spitzer legacy that has contributed to our present troubles was his Ahab-like pursuit of Hank Greenberg, effectively kicking him out of the executive suites of the insurance company Greenberg did so much to build -- AIG.

The US government has now effectively nationalized AIG, on the ground in essence that Greenberg's successors couldn't handle the job. Well ... why does he even have successors???

Investing in Timminco: Counting on a Miracle

A recent analysts' report, in preparation over a period of three months, suggests that investors should be very wary of Timminco, a Canadian silicon-processing company.

The report, by Neeraj Monga and Chris Silvestre of Veritas Investment Research, was picked up on last week by a reporter for the (Toronto) Globe & Mail.

Timminco claims to have developed a revolutionary way of producing the silicon used in solar cells at low cost, a claim that is certainly an enticing one in the present lets-escape-from-hydrocarbons climate.

These claims became especially newsworthy this spring when Sprott Asset Management went public. Timminco's stocks are central among those assets Sprott has been managing of late.

The Veritas report says: "Our review of industry literature, the view expressed by various industry participants in public forums, circumstantial evidence surrounding lack of progress in volume delivery at Timminco, a convoluted ownership structure ... all suggests it will be a miracle if Timminco can deliver on its promises."

The story is worth following, because this is one of several cases in recent years when a company experiencing a stock price drop has blamed malicious rumors spread by short sellers. And, as with many other such cases, those malicious rumors turn out to be true. The short sellers were on to something.

I could name some other examples of company's blaming shorts for telling truths, but instead I think I'll just move on to a couple of bits of housekeeping.

Damien Park, of Hedge Fund Solutions LLC, has started a new blog on "activist investing."

If you're interested enough in the struggles for control in corporate suites to be reading Proxy Partisans, you'll probably want some familiarity with Park's new site, too.

In other news of a bibliographic sort, CRC Press has published an Encyclopedia of Alternative Investments, edited by Greg N. Gregoriou.

I haven't seen it yet. But Gregoriou, an associate professor of finance at the State University of New York (Plattsburgh) has an impressive reputation in the field.

Stay groovy.

Berliner charged with securities fraud

The SEC has charged Paul Berliner, formerly of the Schottenfeld Group LLC, with securities fraud and market manipulation.

It claims (he neither admits nor denies -- though he has settled) that he intentionally spread falsehoods about Alliance Data Systems (ADS) while selling ADS short.

Some background. Last May, ADS -- a company that does something for retailers that involves processing their credit card transactions -- agreed to be acquired by The Blackstone Group, at a price of $81.75 a share. During the period between such an announcement and the actual consummation of the sale, the price of the target company often fluctuates, sometimes rising avove the bid price on speculation that the would-be buyer will have to improve its offer. Sometimes, on the other hand, the target company's price will stay at a discount below the bid price because there will be some skepticism in the market about whether the deal will go through -- whether, especially, the stockholders and the necessary regulatory bodies will sign on to it.

In fact, the ADS/Blackstone merger never happened. The reasons? that's in litigation. Blackstone says it was a regulatory problem -- the Comptroller of the Currency raised objections, because ADS owns a bank. [Actually, it owns two banks, but only one of them is under the regulatory authority of the Comptroller.]

At any rate, the merger was still pending in November, when the stock price for ADS went for its thrill ride, at the Red Flags Theme Park.

Enough background. The gist of the complaint is that during a five minute period in the early afternoon of November 29, Mr. Berliner sent instant messages to 31 other traders/securities professionals that Blackstone was twisting ADS' arms into accepting a lower stock price as part of the merger -- that it would acquire the company at only $70 a share.

When Berliner began disseminating this misinformation, ADS price was selling at $77 a share, so some (justified) skepticism that the $81.75 deal would ever go through was already priced into the stock. But, according to the SEC, what Mr. Berliner was i-m-ing around was simply false: Blackstone had not proposed a lower acquisition price, nor was the ADS board "now meeting" on the subject.

As the rumor spread, the stock price cratered. The intra-day low was $63.65 -- or 17% less than the pre-rumor value.

This enabled Berliner to cover his substantial short position and pocket a quick profit.

In consequence, the SEC brought this lawsuit in the federal district court in Manhattan, and simulatneously settled it. Mr. Berliner agreed to "disgorge" (I love that word) $26,129 in profits and interest, to pay a maximum third-tier penalty of $130,000, and to consent to the entry of an SEC order barring him from association with any broker or dealer.

There is more that might be said about this case, of course. I hope to say a bit of it tomorrow.