Thoughts on the Financial Media

Since it came up in discussions regarding my last post, I wanted to touch upon the issue of the financial media a bit more. I think it is important for investors to understand why media outfits like the NY Times (NYT) might not be the best resources to use when making investment decisions. Recent events involving a story the aforementioned paper published about Warren Buffett’s interest in buying a 20% stake in Bear Stearns (BSC) bring the issue to light even more.

For those that didn’t hear about it, shares of Bear Stearns rose more than 10% on Wednesday after the NY Times reported that Buffett was one of several parties discussing the purchase of a minority stake in the troubled investment bank. Within minutes other reporters were playing down the story after speaking with sources they have within the industry. The next morning, Bear even refuted the story itself on a call with investors. Lots of people have lost money due to what looks to be an erroneous report. Most likely someone leaked the story to a NY Times reporter, assuming they might publish it, causing a temporary jump in the stock price, allowing them to sell some stock at a nice profit right before the end of the quarter.

Now, yes, that explanation as to why it all happened is purely speculation on my part. However, based on what happens all the time on Wall Street, coupled with the fact that the story was immediately rebuffed by numerous sources, including Bear Stearns, leads me to be cynical and suspect that the Times did not check with many reliable sources before reporting Buffett’s supposed interest.

I bring this up because media outlets are not the most trustworthy of resources when trying to gauge the merit of a particular investment. The NY Times is often guilty of this because they are based in the financial capital of the world and have access to lots of Wall Street people, but many other media people make the same mistakes.

It shouldn’t really be all that surprising though, that is, the fact that newspapers and the media in general is often biased in their reporting. In recent months, the NY Times has published numerous stories, from numerous reporters, regarding many different financial corporations including student lending firms, credit card issuers, and mortgage companies. Some of these firms I am invested in, so although I don’t read the NY Times regularly, I have seen some of the “journalism” that has been published to the extent that it has caused stock price movements that interest me.

It is no secret that the Times has a liberal bias in many cases, and some of their attacks on large consumer lending companies makes it clear that some of their reporters are purposely trying to criticize large financial institutions for their lending practices, whether it be to college students, sub-prime home owners, or credit card dependent consumers. I guess it’s just the world we live in.

Now don’t get me wrong, I am all for throwing the book at companies that break the law or act in extremely unethical ways. By no means am I arguing that unlawful acts should not be punished to the fullest extent, and please don’t assume that I am writing strictly to make a political point. Most times I am successful in separating my political beliefs from my job as a stock picker, not only because it serves me and my clients best by doing so, but also because the views are often at opposite ends of the spectrum.

However, since consumer lending activities have become such a big issue lately, the media has started to really cross the line, in my view. It has, in part, I believe contributed to the fact that many Americans feel like they are constant victims of big business, whether it be the oil companies’ supposed price gauging (which there is no evidence of), or any type of consumer lending that has been called predatory in nature without any evidence to support the claim.

Stories in recent months from the likes of the NY Times have sharply criticized many financial institutions, and in some cases, have even gone as far as insinuated that they are breaking the law. Some examples of these horrible activities include student loan companies that factor in things like career path and which college you attend when determining your loan eligibility and interest rate, or mortgage companies that are offering wealthier white borrowers loans more often, and at more attractive terms, than minority, less wealthy borrowers. It turns out, in fact, that mortgage companies also offer their sales people higher commissions for more profitable adjustable rate mortgages than they do for fixed rate versions (much like stock brokers usually try to sell clients annuities — they have high fees and sales commissions of up to 8%!).

Now, if you read these stories without a cynical tilt you are more likely than not going to conclude that companies like Countrywide (CFC), Sallie Mae (SLM), and JP Morgan Chase (JPM) are crooks who are discriminating against anyone and everyone in the name of profitability. Those profits in the end wind up in the hands of wealthy executives and shareholders, which results in an ever-widening gap between the wealthy people making the loans and the less wealthy ones receiving them. This press coverage does result, at least in the short term, to lower stock prices and a general anger toward big business in general. In my view, these attacks are not only often unfair, but in some cases completely one-sided and oftentimes based on assumptions that are simply untrue.

For instance, is it fair to imply that it is at most illegal, and at least unethical, to factor in what degree you are seeking and what school you plan on attending when deciding whether or not to offer you a student loan and at what interest rate? Believe it or not, lenders offer loans to people based on what they think the odds are of being repaid. The better your credit, the more likely you are to not only get a loan, but also a low interest rate. Lenders need to consider this issue more than any other when deciding who to lend money to. The higher the risk, the less often you will qualify for a loan, and even when you do get approved, your increased credit risk results in higher interest rates.

Now, does anyone think that which college you attend and which career path you are pursuing might be relevant factors in determining a borrower’s creditworthiness? The fact is, there is a direct correlation between education, career, and annual income. It also stands to reason that the more money you end up making, the higher probability there is that you will be able to pay back your student loan. Therefore, is it unfair to accuse Sallie Mae of illegally discriminating based on school choice or career path? Most economists would say “yes.”

The same arguments can be made on any number of fronts. Do a smaller percentage of minority borrowers get low interest rate loans because of their skin color and ethnic background, or is it because of their credit worthiness? Most likely, the latter. That does not mean we should not strive to put in place policies that seek to get minority education levels and incomes on par with everyone else, it just means that accusing the banks of racism is probably crossing the line.

The current mortgage and housing industry downturn we are seeing is partly due to the fact that lenders actually abandoned these basic lending principles. Traditionally, the better your credit history, the better loan you were offered. Not surprisingly, the housing boom led companies to get greedy. The more loans they made, the more money they made (at least in the short term, as we are finding out now).

The result was that the lenders completely turned their lending practices on their head. If you couldn’t afford a standard 30 year fixed rate mortgage with 20% down, a new type of loan was created for you allowing little or no down payment and an attractive teaser interest rate. All of the sudden, people who couldn’t get loans were able to go out and buy houses they couldn’t normally afford. And that’s how we got ourselves in this mess.

Amazingly, we lived in a world where the better your credit, the worse your loan terms! High quality borrowers put 20% down on their house and paid 6% interest while sub-prime borrowers put less down and got low single digit introductory rates. How on earth does that make any sense?

It doesn’t, but people are paying for it now. Many lenders have either gone out of business or are losing money hand over fist now since they failed to align the credit worthiness of the borrower with the loans they were offered. And yet, some people want to criticize smart lenders for doing their due diligence and aligning credit histories with interest rates.

Consumers are also to blame since those facing possible foreclosure are constantly being quoted as saying they were so intent on getting their house that they didn’t read the loan agreement before signing it. Well, if you were about to be loaned hundreds of thousands of dollars and didn’t bother to take the time to read the paperwork to find out how much that loan was going to cost, maybe it’s your fault for taking the money just as much as it was the lender’s fault for offering it to you.

I’m getting a little sidetracked here, but the basic point is this. It is imperative that lenders size up the creditworthiness of borrowers to determine loan terms that are appropriate to compensate them for the repayment risk they are taking. Doing so is not illegal or unethical, although hundreds of biased press stories will try to convince you otherwise. These issues are all coming to a head in 2007 and due to the highly divided political landscape our country is facing, people are becoming more and more inherently biased. It’s a shame that this is the case, but it is simply reality. And it’s not just the Times, of course. Conservative papers will be coming from the exact opposite end of the spectrum. It’s just the world we live in today.

This is important from an investing standpoint because you need to consider these issues if you are going to allow the media to play a role in your investment decisions. I would recommend that you not base your investing on what you read in the media. Due to inherent biases, there is going to be information left out because it doesn’t prove a certain desired point, and other information is going to be embellished to make a certain case seem even stronger.

The best thing to do is to base your decision on the facts, not on opinions. In many cases that means taking what public companies say at face value. It is true that there will always be Enrons and WorldComs in this world. However, there are far more biased press reports that ignore facts than there are crooked companies and executives. If you are trying to research a company’s mortgage portfolio, for instance, and the company is willing to break out in agonizing detail exactly what loans they have made (what the delinquency rates are, what the credit scores of the borrowers are, etc.), then you are probably better off analyzing that data than the opinions expressed in the media.

If a company is unwilling to disclose the data you feel you need to make an appropriate investment decision, then find another company that will. In the world we live in today there are too many people with an agenda or a bias that colors what they feel, think, and publish. Heck, I’m guilty of it too. If I’m going to write about a stock that I am invested in, won’t I tend to be bullish? Of course.

However, the merit of my opinion can be greatly increased if I use facts to back up my assumptions. If someone offers up facts and you agree with their underlying assumptions, it is far more likely they will be right. If you read or hear something with a lot of opinion and speculation, but little in the way of facts (say, for instance, in the case of Warren Buffett’s supposed interest in buying Bear Stearns), perhaps it is prudent to be more skeptical.

Take the case of Bear Stearns, for example. On Wednesday the NY Times reported that Warren Buffett was discussing taking a 20% stake in the company. There was no evidence in the story that suggested the rumor had any merit. Within 24 hours numerous reporters were doubting the story after talking with their sources and Bear dismissed the rumors directly. We cannot know for sure if Buffett will wind up buying a 20% stake in Bear Stearns, but based on the factual information we have, I wouldn’t be willing to bet any money on it.

Full Disclosure: No positions in the companies mentioned at the time of writing

Forget Betting on NFL Games, Wager on Fantasy Performances!

I probably wouldn’t have seen this story if I didn’t have a merger arbitrage position in Station Casinos (STN), but I’m glad I did. It turns out that Station sports books in Vegas are now going to let you bet on your fantasy football players. Here is the first couple paragraphs of the AP story:

Vegas Sports Book to Take Fantasy Bets

Thursday August 30, 12:33 pm ET

By John Mcfarland, Associated Press Writer

Las Vegas Sports Book to Start Taking Bets on Players’ Projected Fantasy Statistics

The billion-dollar business of fantasy football is getting another new player: Las Vegas oddsmakers. Station Casinos Inc., the fifth-largest sports book in the country, was to become the first to release a betting line — at 7 p.m. EDT — and start taking wagers based on players’ projected fantasy statistics.

So instead of plunking down a bet on whether the Saints will beat the Colts next week, or how many points will be scored, a better in Vegas can wager that Reggie Bush will finish with more than 16 fantasy points. Or that Peyton Manning might be under 21.

I can just see it now. People betting against their own fantasy roster to ensure they win some cash, either from their bets or from winning their fantasy league. It really is a good idea for Station though, as I have no doubt there will be enough people doing this to make it worthwhile for their books.

Full Disclosure: Long shares of Station Casinos until the merger closes

Barron’s Points Out Cramer’s CNBC Performance Fails to Impress

A very interesting cover story in Barron’s this week about CNBC market guru Jim Cramer and the track record of his investment recommendations on his nightly television show, Mad Money. Essentially, Cramer’s picks were found to have lagged the market over the last two years. While certainly not surprising to professionals, many retail do-it-yourself investors need to be aware of this story.

I wanted to write about it because I get a lot of emails asking about certain stocks, and very often the inquiries I get coincide exactly with new Cramer picks. Given Cramer’s successful stint as a hedge fund manager, many may be surprised to learn that his picks don’t perform well at all relative to the overall market. However, there are reasons this should not be very surprising.

The most glaring that I can think of is that Cramer needs to fill an entire hour of television time five days per week. That means he needs to come up with a handful of “great, new investment ideas” each and every day. Logic should tell you that there simply aren’t that many great investment opportunities. How much confidence do you think he truly has in every pick he highlights on his show? He might not concede anything himself, but watchers of his show should keep in mind that making so many picks almost ensures that you get a good mix of bad ones to go along with the good ones. You really can’t expect anyone, Cramer included, to post market-beating results while giving out so many recommendations.

You should also keep in mind that Cramer is no longer in the hedge fund business, he’s in the entertainment business. He wants to bring in viewers and in trying to do so, he needs to make it interesting so people keep coming back. In doing so, it would not be surprising to think he might try and get viewers a little more excited about his picks than is warranted. In trying to boost his ratings, it is understandable that he might cheer lead a little bit more than the typical market professional. Not surprisingly, this might set his picks up for disappointments on the performance front.

I’ll leave this topic with one more point about Cramer. To his credit his record at Cramer Berkowitz, his hedge fund, was very good. I believe his investors’ returns net of fees were around 24% annually, or something in the mid twenties (I read his autobiography, but it was awhile ago). This number, on the surface, appears to be excellent. However, keep in mind a couple things about that figure.

First, Cramer ran his fund from the early 1980’s through the 1990’s. Essentially, his time running money professionally overlapped exactly with the greatest bull market our country’s stock market has ever seen. I believe the S&P 500 compounded at around 15% per year during his hedge fund days. So, it’s not like he was making 20-something percent during a time when making money was difficult.

Second, if you read his autobiography, Confessions of a Street Addict, you’ll learn that he made a lot of that money in some pretty interesting ways. Since he was a big player, he made tons with IPO share allotments that he was allowed to flip on the first day of trading, which amounted to free money with little risk. In his book he also talks about how he would get word of analyst upgrades and downgrades before the information was made public to everyone, because his firm was a big client of the investment banks who issued sell-side reports.

If you factor in the market averaging 15% and throw in the other ways in which Cramer was able to make money for his clients with very little effort or insight, you might understand a bit more why his picks on Mad Money have left much to be desired. If you want to learn about the market and be entertained, Cramer can have a lot to offer. For stock picks though, I would not suggest you tune in for that reason alone.

Apple, Not Amazon, Should Buy Netflix

Rumors of a merger between Amazon (AMZN) and Netflix (NFLX) have been rampant for months now, with the latest sending Netflix shares up over $25 each last week. However, with Blockbuster (BBI) lowering prices on their online movie rental service, Netflix is slumping back down to $20 per share. Amazon seems to be trying to get their hand in everything these days, which is probably why rumors of a Netflix purchase won’t go away. However, given the price tag that it would take to land Netflix (about $1 billion after accounting for the company’s $400 million in cash), I think it would make more sense for Apple (AAPL) to make the deal.

Obviously, the mail order rental business won’t be around long term given the move to digital media distribution, so the value in Netflix is their subscriber base. It isn’t clear which method of digital home movie watching will win out five or ten years from now. The retail storefront is already dying, thanks in part to the mail order business, but video-on-demand (VOD) from cable companies like Comcast (CMCSA) seemed like the most reasonable candidate to take over the movie rental industry.

However, Apple TV might throw a wrench into that idea. Being able to purchase movies online, download them to a set-top box, and watch them on your television as well as your computer, iPod, or iPhone could be a game changer. We also learned this week that Apple is in discussions with the movie producers about electronic movie rentals through iTunes, rumored to be $3.99 for a 30-day rental. If Apple can perfect both renting and purchasing movies online, video-on-demand might have a tough time competing since the cable companies would house the content on their own servers, allowing for a lot less mobility and flexibility.

If Apple is serious about rivaling VOD, a purchase of Netflix could make a lot of sense. The mail order business will likely do well until new digital technologies become mainstream, at which point converting users over to a digital model wouldn’t seem to be very difficult. After deducting the cash on Netflix’s balance sheet, an acquirer is paying less than 1 times revenue for their millions of subscribers. I think a Netflix-Apple combination would really match up well against Blockbuster and the cable companies. Netflix is already trying out some new digital download technology to distance itself from Blockbuster, so Apple would be a great partner on that end. An Amazon deal just seems to make less sense, which is perhaps why that rumor seems to never come true.

Full Disclosure: Long shares of Apple at the time of writing

Usually a Contrarian Investor, Kerkorian Takes Aim at Bellagio, City Center Instead

In recent years billionaire investor Kirk Kerkorian and his investment company Tracinda Corp. have been focused on potential value in beaten down automobile companies like General Motors (GM) and Chrysler. However, despite a huge upward revaluation in Las Vegas properties during that time, evidently he still sees value in that area.

Monday we learned that Kerkorian is interested in acquiring the Bellagio hotel and casino as well as a new development project, City Center, which is set to open in 2009. Kerkorian is the majority owner of MGM Mirage (MGM) with a 56% stake in the gaming giant, worth about $10 billion before his intentions were made public. MGM shares rallied 10 points in after-hours trading Monday to $73 per share on the idea that Tracinda might wind up taking MGM private at some point down the line.

The announcement is interesting given Kerkorian’s recent foray into domestic car companies at very depressed prices. MGM Mirage is not a cheap stock (about 12 times 2006 cash flow) but has many growth opportunities ahead, both in Vegas and abroad in Macau. Such a move indicates that he is not worried about a severe economic slowdown, which would almost certainly adversely impact the boom in Las Vegas and Macau that has been very strong during the current worldwide economic expansion. With Kerkorian still willing to buy at these levels, he must think those predicting doom and gloom on the economic front aren’t likely to be vindicated anytime soon.

Full Disclosure: No position in MGM Mirage (unfortunately) or any other company mentioned at the time of writing

Gordon Gekko Coming Back?

The movie Wall Street starring Michael Douglas as a greedy corporate raider in the 1980’s is a classic and although two decades old, it appears the film will be making a comeback. According to a New York Times source, Gordon Gekko is back. Edward Pressman, the producer of the original film, has signed on to make a sequel entitled Money Never Sleeps. Other movies have tried to duplicate Wall Street’s success, Boiler Room comes to mind, but none have really been able to do so. Sequels are rarely as good as the original, but this project is definitely something that has the potential to be a pretty solid film.

Could the Bancroft Family Reject a 67% Premium for Dow Jones?

One of the things I look for when picking stocks is high insider ownership. The logic goes that you want people running the company you own to have their interests aligned with yours. Who is more likely to act in the interests of shareholders, someone with a guaranteed salary and bonus or someone with a large stake in the company and performance-based compensation?

However, few companies do fact have high insider ownership, so finding examples that fit the bill can be difficult. If a CEO gets options that are priced below market and vest immediately, he or she will likely sell them right away and not see any meaningful ownership maintained for the long term.

In the case of media company Dow Jones (DJ), you have very high insider ownership (the Bancroft family controls 64% of the voting rights), so you might think they have shareholders’ interests at heart. However, we get news that News Corp (NWS) has offered $60 per share for DJ, a premium of 67 percent, and yet reports have surfaced that the Bancrofts may be prepared to vote against the deal.

How on earth can the Bancrofts reject a $60 cash offer when their stock is trading at $36 per share? Isn’t that a huge disservice to DJ shareholders? Don’t they have a fiduciary responsibility to take the deal? Legally, probably not. They can vote their shares any way they want. Other shareholders should have been well aware that the family has been against a buyout for years, and should have taken that information into account when they made the choice to invest in the company.

Although the Bancrofts have every right to reject the offer, they should do the right thing for their other shareholders. They should take the company private. If you want to keep the company in your family, as it has been for more than 100 years, that’s fine and very understandable. However, when you are part of a public market, you do have a responsibility to your fellow shareholders. It might be legal, but it is absolutely unfair to DJ investors if you reject a $60 offer for shares that the market says are only worth $36 each.

The “low-ball offer” defense won’t work here. If you want to make financially irrational decisions, then take the firm private and run it any way you want. If you want to open the company up to outside investors, then make sure you treat your shareholders with respect. You own the stock, so it’s your choice which road to go down, but it’s unfair to try and have your cake and eat it too. People invest in public companies to make money. If you make it impossible for them to do so, then you shouldn’t be in the public marketplace in the first place.

Full Disclosure: No position in any of the companies mentioned

Blockbuster Lays Out Growth Targets

Blockbuster (BBI) CEO John Antioco, speaking at an investor conference yesterday, said his company could double its online DVD subscriber base to over 4 million during 2007 as its Total Access promotion continues to pay off. Antioco said that in the 60 days since Total Access was unveiled, Blockbuster has signed up 700,000 new subscribers.

These growth numbers are very interesting. Netflix (NFLX) only added approximately 650,000 subscribers in the fourth quarter, which implies that Blockbuster is ahead of its main competitor in grabbing new business right now. Blockbuster stock is reacting positively, as one would expect, jumping 5% to over $6 per share. It will be interesting to see how Netflix’s 2007 growth projections are impacted, if at all, from Blockbuster’s big push aimed directly at them.

Full Disclosure: No positions

Playing the Online DVD Rental Market

After years of trailing Netflix (NFLX), movie rental giant Blockbuster (BBI) has finally realized that it might have a competitive advantage over its main rival; about 8,500 storefronts worldwide. By integrating in-store and online DVD rentals into its new Total Access movie rental program, Blockbuster is finally making some gains at Netflix’s expense.

However, looking at the share prices of both companies, one has to wonder if Wall Street is too optimistic about Netflix’s future and too pessimistic about that of Blockbuster. Despite having annual revenue that trounces NFLX by a factor of four, Blockbuster’s market cap ($1.09 billion) trails that of Netflix ($1.75 billion) by nearly 40 percent. Netflix’s EBITDA for the first nine months of 2006 came in at $46 million, only 25% of Blockbuster’s $188 million.

So, Blockbuster at first blush appears to be a much cheaper stock with 60% of the market cap of Netflix, but with 4 times as much revenue and EBITDA. Even using a P/E ratio, which hurts Blockbuster given they have a fairly high debt load, BBI shares trade at more than a 10% discount to Netflix based on 2007 projections.

Given these numbers, there has to be some explanation for the wide valuation disparity. Growth investors would surely point out that Netflix is focused solely on the high growth online DVD rental market, whereas the bulk of Blockbuster’s business comes from the storefront, which is a deteriorating market.

That said, Blockbuster’s 8,500 stores are worth something, even if it is far less than five or ten years ago, and Netflix has no stores. Going forward, does NFLX have an advantage over Blockbuster when it comes to securing incremental online DVD rental customers? Making the case that they do is difficult, especially since BBI is now allowing customers to return their online DVD rentals at local stores.

Another way to look at it is to analyze the online DVD rental market itself. I have made the point before on this blog that five or ten years from now it is very possible that nobody will be renting DVD’s on a web site and returning them through the mail. The cable companies seem to have a powerful distribution network via the on-demand model, and there is no reason to think that every movie that Blockbuster and Netflix have could be part of a mass digital library, accessible to every customer who has a cable box.

If the online mail order model does indeed go away, it would be hard to argue that Netflix is better positioned than Blockbuster. Both companies could very well die under such a scenario, but Wall Street seems to be unfairly down on Blockbuster’s prospects versus those of Netflix. The current valuation disparity seems pretty drastic to me, and I’m not sure it makes any sense.

As always, your comments and opinions are welcome.

Full disclosure: No positions in BBI or NFLX.

Harrah’s Apparently Underwhelmed by Offer

While some of the less-knowledgeable anchors on CNBC today were saying that Harrah’s was being bought out by private equity, I couldn’t help but sit back and consider the odds that the casino giant accepts the $81 per share cash offer from Apollo and Texas Pacific. After all, the company’s shares opened at $75.42, jumped to as high as $80.01, and closed back down at $75.62 each.

Since I play arbitrage deals every once in a while, a quote of $75 and change would be intriguing indeed, if the odds of a deal were fairly high. It would likely take 6 to 9 months for a deal to close upon an official agreement, which makes for a nice annualized return for merger arbs. However, after thinking it through, I decided not to pounce yet. And the reasons below might partly explain why the stock is more than $5 below the offer price.

If Harrah’s was truly happy with the offer, wouldn’t they have accepted $81 per share? Instead they merely issued a press release announcing that they had received the offer and formed a special committee to consider it. The way I see it, there are only two reasons why Harrah’s would not have agreed to the proposal. Either they aren’t totally sold on the idea of going private, or they are open to it, but want a better price.

Now it’s true that by making the offer public knowledge, other interested parties could emerge and a bidding war could push the price up. However, we are talking about a $15 billion offer for the HET equity, plus another $10 billion or so in debt, for a total deal value of $25 billion. How many other buyers can afford a deal like this? Not many, so a bidding war seems unlikely.

A more plausible scenario would be for other private equity firms to join in on the bid, allowing for a second offer to be extended if Harrah’s balks at $81 per share. With more investors, the acquiring group can increase their bid, and at the same time, reduce the amount that each must put into the deal.

Who knows exactly what Gary Loveman and the other folks at Harrah’s are thinking here. The offer does represent a 22% premium, but is also slightly below the stock’s 52-week high. Loveman, the CEO of Harrah’s, likely won’t have to worry about losing his job, since it is unlikely that private equity firms have a seasoned gaming executive who would be a better fit for the company. Going private does take away the flexibility of paying for future acquisitions with stock, rather than cash, so that could be a consideration as well.

So how should investors play this? Current holders of HET should hold on, since anything is possible and the stock is not most likely not overvalued at $75 per share. If you are considering getting in as an arbitrage opportunity, make sure you do a stand-alone valuation for the company and feel confident that there is not much downside longer term at $75 should no deal materialize. And finally, for you corporate bond investors out there; Standard and Poor’s downgraded Harrah’s debt to junk status after word of the offer hit the wires. This seems silly to me.

It should be interesting to see how this all plays out and as events unfold, I’ll be sure to post my thoughts.