Despite Headwinds, Record Short Interest Suggests Future Strength

Short interest on the New York Stock Exchange rose to record in the month through April 15, according to figures released in late April. The NYSE said short interest rose to 8.44 billion shares, up from the previous record of 8.42 billion shares on March 15, and was equal to 2.3 percent of total shares outstanding.

Despite $50 per barrel oil, higher inflation, and a Fed that many believe will continue to raise the Fed Funds rate to 3.5% or 4.0%, these numbers from the NYSE are too glaring to ignore. Bearish sentiment is one of the most reliable historical indicators of future price appreciation in the stock market. In fact, the 2005 short interest record shattered the mark set in late 2002. A quick look at what the market did after that makes the case even more compelling.

Playing the Neiman Marcus Arbitrage

Shares of Neiman Marcus are trading down $5 this morning, to $93.25, on news that the company is being purchased for $100 in cash. Many investors were looking for more money out of a buyout. Existing shareholders may be upset with the price, but today’s drop gives others a great chance to play an arbitrage trade.

The deal is for cash and is expected to close by November 1st, so we’re looking at a 6-month time frame. The share price of $93.25 trades at a 7.2% discount to the buyout price, plus there will a 15-cent dividend payment in August. Buying the stock and holding until closing will net investors nearly a 15% annualized return with very little, if any, risk.

Side notes:


Sirius Satellite CEO Mel Karmazin on CNBC is quoted as saying “We don’t think of XM Satellite Radio as our competitor.”

Really? Perhaps that explains why they are so far behind XM in terms of subscribers, cost structure, and technology.


FBR’s food and beverage analyst just said on CNBC that he would not recommend selling Starbucks (SBUX) stock at its current price of $49.67 per share. When asked what his target price was, he said $50. I can’t help but laugh outloud when I hear things like this. Do people really take comments like these seriously?

Morgan Stanley’s Purcell To Stay, For Now

The TradeSports contract on whether Phil Purcell would be fired or resign as CEO of Morgan Stanley by June 30th was always overpriced, representing a great opportunity for traders who wanted to short it. It has been widely speculated that Purcell would be ousted in the latest battle to get Morgan back on the path to respectability.

The only problem was that the company required 75% of its Board to vote Purcell out, which equated to 10 of its 13 members. The presence of Purcell and two of his buddies (who found themselves there exclusively because of him) made it extremely unlikely he would be removed by mid-year. That would require each and every one of the remaining Board members to vote to boot him.

CNBC’s Maria Bartiromo reported late Friday, after a report was first published in the Wall Street Journal, that a Board meeting would take place over the weekend in Chicago, sparking speculation that Purcell’s reign was over. The TradeSport contract doubled in value to 50 cents in no time, yet another shorting opportunity.

Word came Sunday that rather than fire Purcell, the Board would change its bylaws to require only a simple majority, or 7 out of 13, to replace him as CEO. The contract tumbled 70% to 15 cents. It appears Purcell will get a chance to spin off the Discover credit card unit and try and bring the company back. If he continues to prove unsuccessful as a Chief Executive, you can bet it won’t be very difficult to get 7 “yes” votes to force him out.

As for the stock, it’s cheap at $52 and might fall back to the $49-$50 area on news that Purcell is staying put. Value investors should use any weakness to add shares. Very few scenarios will cause the situation to get much worse. Either Purcell starts doing his job, the company gets sold, or someone new comes in to lead Morgan in a new direction. Any and all of those options will increase shareholder value from here.

Great Quarter for Yahoo!

So much for the soft pricing on online advertising that RBC Capital Markets analyst Jordan Rohan cited in his negative comments toward Yahoo (YHOO) and Google (GOOG). Yahoo’s quarter came in meaningfully ahead of expectations, with EPS at 13 cents and revenue at $821 million, versus analyst estimates of 11 cents and $797 million.

The stocks of the online search and advertising companies are reacting very positively in after-hours trading. YHOO is up more than $2, with GOOG up $12, and INSP rallying 3% after a 4% gain during the regular session. No doubt that the shorts will be forced to cover before the latter two companies report their Q1 numbers.

Both Google and InfoSpace appear to be cheaper than Yahoo, so I’d stick with those two names in this sector.

Plains Exploration Update

Here’s a quick update to the piece I wrote on April 1st regarding one of my favorite energy stocks, Plains Exploration (PXP). If you missed it a few weeks back, you should take a look, but the jist of it was that Plains sold some oil wells to XTO Energy (XTO) and used the proceeds to get rid of some old oil price hedges it had in place (that were preventing it from reaping the full benefits of $50+ oil).

As I pointed out, the stock was up 3% that day, to $36 a share. Since then, oil has fallen from a high of $57 to the current $50, and Plains stock has dropped from 36 to 31. It was obvious that earnings estimates were going to rise with the new strategy, but how much exactly was unclear on the day of the announcement.

Well, a quick look at Wall Street’s updated profit numbers for PXP shows even more of a positive impact than I had anticipated. EPS estimates for 2006 have gone from $3 to $4 per share. The stock, meanwhile, has dropped 15 percent. The current P/E on ’06 is less than 8 times.

On days when oil prices are weak and the stocks are suffering, Plains is one stock that should be accumulated, in my opinion.

Sirius Inks Martha Stewart Deal

Back in the hey day for satellite radio stocks, today’s news that Sirius Satellite Radio (SIRI) has partnered with Martha Stewart Living (MSO) to create a 24/7 radio channel would have most likely resulted in a 10% jump in Sirius stock. Not so today though, as MSO added 6% while Sirius lost 1% of its value.

I think there are many reasons why Sirius shares were down on this news. First, I highly doubt this channel is going to prompt hundreds of thousands of women to sign up with Sirius. Perhaps even more problematic for Mel Karmazin’s company is the structure of the MSO deal. Once again, Sirius’s business model is flawed with this new channel. MSO is putting nothing into the joint venture. That’s right, no cash outlay whatsoever. In essence, they are taking on no financial risk, and getting free marketing in return. Sirius, meanwhile, is footing the entire bill, and not getting anything except hope that women will flock to Sirius to tune in.

XM Satellite Radio (XMSR) continues to lead the industry, with 3 times as many subscribers as Sirius. Even worse, the majority of new subscribers are going to XM. The Sirius model is not working from a financial perspective, as evidenced by their far inferior margins. Deals such as the one inked today are not going to help this company reach cash-flow positive, which is needed for the stock price to prove reasonable.

Interestingly, XM’s market cap still trails Sirius, despite having more than 200% more subscribers and a better path to profitability. Makes for an interesting arbitrage opportunity for the aggressive investor.

Look at MCI Stock Go

Crappy companies these days seem to have a surefire way to get back on the road to riches. Go bankrupt!

Evidently, Kmart wasn’t the only company that could execute this wonderfully successful strategy. Now MCI, the company formerly known as Worldcom, is out of bankruptcy court and it’s stock is flying. Granted, shares of MCIP did get crushed right after emerging from the dead, but if investors timed their purchase well they could have made a nice chunk of change. The stock has doubled from its lows and now sits at post-fraud high of 26.

Contrasting the Kmart and MCI stories is very interesting, to me at least. Eddie Lampert and his hedge fund, ESL Investments, was able to buy half the company on the cheap when nobody else wanted it while it was in bankruptcy. I probably don’t have to tell you, but he has made 900% in two years as the stock has soared from 15 to 150.

It turns out that even though MCI was in the very same situation after their massive accounting fraud was uncovered, nobody swept in to take control of MCI. If they had, they would have gotten a relative bargain. Now we have Verizon and Qwest in a bidding war that is sending MCI stock to new highs.

Why weren’t these companies interested a year and a half ago? All of the sudden they are now and as a result will have to pay the price for such a boneheaded mistake. In any case, I highly doubt there is anywhere near the value in MCI that there was in Kmart.

What Bull Market?

I’m still trying to figure out why I keep hearing investment strategists proclaiming that the bull market remains intact. Do these people really think we are in a bull market? Do the numbers support that conclusion? Does this market feel like it’s going gangbusters? I have to say “no” on both counts.

First of all, the market is down since the turn of the millennium, and we’re more than halfway through the decade already. I hate to break it to everybody, but the bull market in stocks ended in 1999. It was the greatest bull market of all time, lasting a full 18 years beginning in 1982. During that stretch, the S&P 500 returned an average of 19% per year and recorded only 1 down year (a 3% loss in 1990).

It takes more than a couple of down years to get the bull running again. If stocks average 5% a year for the rest of the decade (which I think is entirely possible, if not probable), the average return for the decade will be 2% per year. When stocks fail to keep pace with inflation, it’s not a bull market.

That said, there is no reason investors can’t attain double-digit returns in a bear market. It just means that index funds won’t do the trick. Superior stock selection will.

Why Do Analysts Hate NOVA Chemicals?

Investors can look to three places for thoughts on a particular stock; Wall Street analysts, the company itself, and one’s own personal opinion. Shares of NOVA Chemicals (NCX) have dropped 12 straight points. The analysts hate it (Prudential just slapped a “sell” on the stock yesterday). The company is very upbeat and current earnings estimates look impressive. So why is the stock getting crushed?

I think the main reason is that chemical companies are very cyclical and are extremely reliant on commodity prices cooperating in order to make a nice profit. With input prices rising and uncertainty as to if that trend will continue or come back down to earth, investors are afraid of these stocks.

That said, at what point do we say that all of that has been more than priced into the shares? NCX stock trades at 9.3x 2005 estimates and 5.7x 2006 profit expectations. Yes, that’s less than six times earnings! Even if you use the lowest estimate for 2006 on the Street, you get a P/E of 7.4x.

Investment theory says that low P/E’s on cyclical companies are a signal of a peak in their profit cycle. However, the company is fairly early in their recovery and company executives don’t see 2006 as the peak. Instead, they figure 2008 is a better guess. NOVA is a controversial name in a controversial industry, but I think the stock is worth much more than $40 per share.

Siebel Warning Slams Software Sector

In case you haven’t noticed, software stocks have been very weak recently and a profit warning from Siebel Systems (SEBL) last night only added fuel to the fire. The first quarter is always seasonally weak for enterprise software spending, so poor Q1 reports aren’t totally surprising. I am not a fan of SEBL, but other software names I do like, including Tibco (TIBX) and Ariba (ARBA), are feeling the pain in sympathy with the entire group. As 2005 progresses, business should improve and the stocks should rebound nicely. Today’s prices will be a gift in such a scenario.