I have a small favor to ask today...
I'm about to tell you how I know exactly when Continental Airlines will go bankrupt. You might recall my similar work on GM. I spent about two years explaining, quarter after quarter, that there was no way the company could escape bankruptcy. Even though such information can be incredibly valuable to stock traders, my work inspired a lot of anger from our subscribers, who didn't understand my reasoning had nothing to do with cars, or "America," but simply with mathematics. GM's enormous debt load ($172 billion at last count) couldn't be supported by the car company's dwindling market share and negative profit margins. At a certain point (I'd say 2006), it became mathematically impossible for GM to ever make enough money to repay its obligations. The interest payments were compounding faster than it could ever hope to grow the business, and it didn't have enough equity left to refinance.
These situations are tragic for investors, employees, and customers. There are no easy explanations for why companies sometimes end up in these "no way out" scenarios. Thus, it may seem crass or even immoral for me to demonstrate how these situations can be the best investment opportunities of all. But I'd ask that you, if only for a minute, put aside these "good neighbor" emotions. You see, when you buy a stock, an endless number of things might go wrong. As an analyst, it is impossible for me to identify every possible business risk. And as you know, sooner or later, everything that can go wrong will go wrong.
On the other hand, when you're researching companies that are truly stuck in "no way out" scenarios, there aren't any realistic alternatives. No matter what else happens, their debts and interest payments will come due. And that means you can know, with a far higher degree of certainty, what your investing outcome will be. And so, I ask you: Would you rather own a stock that may or may not increase in value? Or would you rather short a stock that you can know, for certain, will go bankrupt by a specific date in the future?
This kind of analysis has always appealed to me because of the certainty. Most subscribers don't know my very first newsletter, written in 1999, accurately predicted the demise of the original AT&T, which was the most widely held stock in America at the time. Most recently, I told my subscribers Continental Airlines will go bankrupt. And now I can even tell you when...
The company has $105 million of equity sitting under more than $12 billion worth of debt. It operates at a loss because its gross margins have fallen in half in only three years. Fuel costs and competition have rendered its full-service, high-cost, and unionized business model obsolete – much like what happened to General Motors. It has $900 million worth of lease and capital obligations coming due this year and only $2.7 billion worth of cash left. In 2011, 40% of its $6 billion in long-term debt will come due.
But the trigger for Continental's bankruptcy will be an obscure clause in its credit-card processing agreement with Chase Bank. The agreement requires Continental to maintain at least 25% of its current obligations in cash. Next year (2010), the portion of its long-term debt that's due in 2011 will become "current" – due within the next 12 months. That will cause Continental's current obligations to soar to nearly $7 billion. At the same time, its cash reserves will be falling. The collapse of the current ratio will trigger a cascade of debt defaults, pushing the airline into bankruptcy. Thus, Continental will go bankrupt at some point in 2010.
I know Continental can do nothing to avoid a default. It only has $105 million of equity left. That's simply not enough to restructure its debts. And it can't operate profitably enough to afford to repay its debts – it doesn't even have enough cash to pay for the planes it has already agreed to buy from Boeing. If you short the stock today, I'm 100% sure you will double your money in 12 to 18 months.
Now... about that favor. I've been working since early March with a new analyst, Braden Copeland, to publish Inside Strategist. We've done well together for our readers, and I can tell you Braden is the most talented stock analyst I've worked with since I started working with Dan Ferris back in 2001. He is very, very good. We want to collaborate on a new research project – finding more stocks like GM and Continental, companies with "no way out." A lot of companies added far too much debt over the last 10 years. Dozens will not survive. That's a big opportunity for investors who aren't afraid to sell stocks short. But...
We aren't sure if publishing this kind of research is practical. We may only be able to identify two or three large companies each year as having "no way out." Of course, that's plenty if all of them are going to zero. But would you buy a research service that covered a new stock once a month, but only actually led to a recommendation two or three times per year? And would publishing such a letter be too offensive to most subscribers? We might end up damaging our reputation in a way that costs us far more than we're able to earn through publishing such a "no way out" letter.
Please share your thoughts about our plans. Let us know if you'd be interested in reading such a letter... or if you think it's the wrong way for us to approach the markets: feedback@stansberryresearch.com.
Speaking of companies stuck with too much debt... The commercial real estate sector is still suffering. Today, Massachusetts-based REIT HRPT Properties Trust paid $135 million in cash for 17th Street Plaza – a 32-story office building in Denver. The sellers, JPMorgan, accepted a price "substantially below the replacement cost" of the building, according to Todd Roebken, a managing director with the commercial real estate firm Jones Lang Lasalle.
JPMorgan bought the building for $135.5 million in 2000 ($168.28 million in today's dollars). Roebken says JPMorgan still came out ahead on the deal considering all the rent it collected. But other sellers of prime commercial real estate property this year haven't been so lucky... This March, the New York Times Co. sold half of its 1.5 million square foot Manhattan headquarters to W.P. Carey & Co. for $225 million. The ailing newspaper publisher built the building for $1 billion in 2007... a two-year price decline of more than 50%.
Mega-REITs Equity Office Properties and Vo
rnado Realty Trust bought the Times Square skyscraper at 1540 Broadway, dubbed the Bertelsmann Building, in 2006 for $820 million. The building sold this year for $355 million... a nearly 60% drop. And in Boston, the marquee John Hancock Tower sold for $660 million. The same building was appraised at $1.3 billion in 2006. These three properties are all considered top-quality assets... And they all sold for at least 50% less than peak prices. The scary thing is, some analysts, including our own Dan Ferris, expect commercial real estate prices to fall even farther...
Of all the publications following the shady dealings of "Government Sachs," music magazine Rolling Stone published the absolute best article we've read – The Great American Bubble Machine. Author Matt Taibbi starts the piece by dubbing Goldman Sachs a "great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money." The article outlines claims Goldman has "engineered every major market manipulation" since the Great Depression. Ultimately, the article blames Goldman Sachs for five bubbles – the Great Depression, tech stocks, the housing craze, record oil prices, and "rigging the bailout." This is an absolute must read... Check it out here.
In October 2007, we realized something was fishy at Goldman Sachs – while other banks were struggling, Goldman was reporting ever-increasing earnings... But the bank owned all the same illiquid assets and made largely the same trades as every other bank on the Street. We were eventually proven right as Goldman's shares fell from an all-time high of $250 to less than $50 a share. You can see a collection of our Goldman Sachs theories and accusations here.
Just as Congress goes to vote on the Waxman-Markey bill (the cap and trade tax on carbon emissions), the Wall Street Journal has published its assessment of how the tax will affect Americans: "Waxman-Markey will cost the economy $161 billion in 2020, which is $1,870 for a family of four. As the bill's restrictions kick in, that number rises to $6,800 for a family of four by 2035."
If you'd like to sign a petition protesting Waxman-Markey, click here.
New highs: Addax (AXC.TO), Crucell (CRXL).
In the mailbag... Do you have experience moving gold offshore? If so, please get in touch and let us know how you did it: feedback@stansberryresearch.com.
"It's painful to read all of the mail from the 'haters' in your Digest and even more painful to think that you have to take the time to respond to them. (Ref: Digest of June 24th) There are a bunch of idiots out there. Keep up the good work." – Paid-up subscriber Jeffrey Bohnsack
Porter comment: If you're reading our letters, you're a heck of a lot smarter than most people because you at least care enough about getting solid information to pay for it. Our subscribers are, with almost no exceptions, successful and intelligent people. Of course, in a large group... a few folks will be "special." And they tend to write the most entertaining letters.
"I have been diligently reading the S&A report as well as my newsletters. I refer to the entry from Doug Casey about having gold in physical possession outside the borders of the US. This makes sense to me. It so happens I have a trip planned to Halifax in Canada next month. I have also started a coin collection based on Steve Sjuggerud's recommendations. It makes sense to me to store some of these coins in a safe deposit box somewhere in Canada.
"This is something I have never done, domestically let alone internationally. My question is how do I get the coins there? Do I just take them with me? Will there be problems at customs? Will there be a bank willing to issue a safe deposit box for me? It is apparent to me that OBAMA! is as totalitarian as can be and the window of opportunity to do something like this is limited. I would really appreciate your input regarding this." – Paid-up subscriber John H.
Porter comment: We don't give any personal advice here. The government won't let us – no kidding. So I can't offer any specifics on your situation. But I can tell you there's no law against taking gold out of the country – at least not yet. Many of the knowledgeable people I've talked to about this tell me they FedEx their gold to places like Panama and Hong Kong. Other people have told me they simply carried it with them when they traveled.
"When you guy's first started talking about gold a couple of years ago, that concept didn't appear on the mainstream radar. Now it seems as though the cat's out of the bag and yet gold really hasn't moved. By now I've heard the case for gold ad nauseum, so where's the beef? When is the Wizard of Oz going to come out from behind the curtain and give the go signal?" – Paid-up subscriber S. Lenahan
Porter comment: I love these kinds of e-mails... While we've always favored owning a substantial amount of gold, we first forecast a big move in gold in 2003. We held several gold conferences showing people which gold stocks and rare coins to buy in 2004 and 2005. For most of this time, gold was trading for less than $400 per ounce.
The chart below compares the pe
rformance of stocks (the S&P 500) to gold, as represented by the gold ETF, since 2005. As you can see, even if you waited as late as 2005 to buy, you would have doubled your money in plain old gold bullion, compared to losing roughly 25% of your money in stocks
Sjuggerud's rare coins have done better and a few of our gold picks (Seabridge, for example) have done much, much better. I would answer your question with this question: What kind of fireworks were you expecting? And I would love to hear from subscribers who took our advice in 2004, 2005, or 2006 to allocate to gold – especially if you were a first-time gold buyer. Please let us know how gold has served you: feedback@stansberryresearch.com.
"I may be one of your 'poorer' subscribers meaning I'm not over the 6 figure income mark but hope to get there. As far as the untaxed masses folks like me with a few kids (6) get most of our payroll deductions back in a tax refund and that is just with standard deductions. The people out there saying the vast majority are paying taxes are fooling themselves. Most married couples with a couple kids under $60K a year are most likely getting everything they paid in on payroll taxes back and sometimes they make a net profit in that they get back more then they paid in. So if you decrease the tax rate for these people what does it do other then increase the federal deficit?" – Paid-up subscriber Trevor Hansen
Porter comment: In a truly free society, where citizens were actually treated equally under the law, everyone would pay the same tax. Not the same rate – the same tax. Limiting taxes to what everyone could afford to pay would accomplish two important things. First, it would force the government to focus only on its legitimate functions, which are to provide for the national defense and enforce contracts. And second, limiting taxes to a paltry sum would castrate any attempt by special interest groups to use the power of the government to take through force what they cannot win in the marketplace. I understand this is a radical view that's wholly unlikely to ever be implemented. A reasonable compromise is to at least insist on citizens paying the same rate of tax. While this wouldn't strictly limit the size of government, it would at least pass along the burden of paying for the government in equal measure.
I've always been fascinated by the legal basis for progressive income tax. The idea that one citizen has a bigger (or smaller) obligation to the state than another citizen flies completely in the face of the ethos of our country. When our founding fathers broke away from the King of England, they did so saying: "We hold these truths to be self-evident, that all men are created equal," which meant the sovereign should treat all men equally. Later, after the Civil War, we framed that idea into our highest law – by adding the 14th Amendment, which says: "No State shall make or enforce any law which shall abridge the privileges or immunities of citizens of the United States... nor deny to any person within its jurisdiction the equal protection of the laws."
The language couldn't be clearer: The states, at least, are required to treat their citizens equally. And yet, most states have steeply progressive income taxes. And even worse, we've seen a flurry of new so-called "millionaire" taxes from states like Maryland and New York. How can they get away with it?
In 1973, the U.S. Supreme Court ruled that the 14th Amendment simply doesn't apply to taxes. The case is Lehnhausen v. Lake Shore Auto Parts Co. Here's the relevant passage of the 9-0 decision:
Of course, the States, in the exercise of their taxing power, are subject to the requirements of the Equal Protection Clause of the Fourteenth Amendment. But that clause imposes no iron rule of equality, prohibiting the flexibility and variety that are appropriate to reasonable schemes of state taxation. The State may impose different specific taxes upon different trades and professions and may vary the rate of excise upon various products. It is not required to resort to close distinctions or to maintain a precise, scientific uniformity with reference to composition, use or value.
The Constitution is a dead letter my friends. It was written to protect us from the government. But unfortunately, the government decides whether or not to enforce it...
"I have hesitated for a long time whether to buy the Stansberry membership that grants access to everything you will ever publish in the future. One of the primary drivers of my interest (as well as the many friends to whom I have recommended your organization for various newsletters) has always been the high esteem I have had for your integrity. But suddenly there seems to be the hint of fish in the air with your decision to put those Iraqi oil small caps in your medical newsletter, which is the only one excluded from the aforementioned membership.
"It looks like you are shortchanging you Badiali subscribers in order to try to dance around the integrity issue – as well as obliging the lifetime members to subscribe to Phase 1 (a MEDICAL newsletter) for access to info that they should have had in their Oil Report subscription. It doesn't affect me directly in any way, since i have two other subscriptions with y'all. But it certainly affects my opinion of your integrity." – Paid-up subscriber Tim Schroeder
Porter comment: When it comes to the integrity of our Alliance subscription offer, I am very happy to stand on our record. Ask any of our Alliance members: We have always lived up to our word to include every new publication. We have always lived up to our word to grow our coverage universe and make the Alliance offer more valuable, year after year. And we have always excluded our small-cap research service, which features conference call meetings.
Our small-cap research service ($5,000-per-year subscription fee) was originally called Diligence. Later, when Rob Fannon became our lead analyst on the project, he requested we change the name to Phase 1 – to signify the start-up and early-stage nature of these companies.
The idea that Phase 1 only covers medical companies is simply wrong. We have covered a wide range of small-cap and early-stage technology and mining companies. You can see this for yourself by simply looking at our Hall of Fame, where four of the 10 highest total return stocks we've ever recommended were Diligence recommendations. Of these, three of the four were technology stocks. Medis technology was a hydrogen fuel cell technology company. Nuance does voice recognition technology. And Airspan Networks was a provider of fixed wireless network equipment.
We have always been extremely clear about the fact that Phase 1 is the only service not included with your Alliance membership. And we have always explained Phase 1 will primarily cover speculative, small-cap companies.
In regard specifically to the incredible opportunities we've been covering in Iraq, the entire May issue of our S&A Oil Report newsletter covers the relevant details. No Alliance subscriber or Oil Report subscriber should feel left out of the story. We beat the mainstream pres
s and got our readers in ahead of the Sinopec deal for Addax – which led to 50%+ gains for our readers in about a month! I don't know how we could have done better for our Alliance/S&A Oil Report subscribers. Additionally, that copy of the Oil Report contains the names of six small-cap companies operating in Iraq. So if you're looking for small-cap names operating in Iraq, you've already got them.
In addition to this research, our team has conducted extensive due-diligence on the Iraqi opportunity and has identified two especially promising small-caps. We can't recommend these stocks to a large group of investors, even if we wanted to do so. There's not enough trading volume. Recommending these stocks to thousands of subscribers would make it impossible for anyone to get in at a decent price. The market makers would simply cream everyone.
That's why we've always excluded Phase 1 from our other sales offers. It's the place where we can share our research on the smallest opportunities with a group of investors wealthy enough to finance the research and handle the extreme volatility of these recommendations. Without subscribers willing to support our micro-cap research, we simply wouldn't publish these recommendations at all.
Some subscribers of our various newsletters are always disappointed when Phase 1 covers an opportunity in their field. I can understand that reaction. But the truth is, this kind of content wouldn't be published in our other letters regardless. In any case, we have always been upfront about the nature of Phase 1 and about the fact that it is not included with the Alliance. I don't think you can accurately fault our integrity for wanting the opportunity to publish research on very small-cap stocks.
Regards,
Porter Stansberry
Baltimore, Maryland
June 26, 2009