The lull before Thanksgiving... Another horrible acquisition for HP... GE bets on natural gas... Obama's third term...
For the traders looking to take advantage of volatility the day before Thanksgiving, we hope you weren't disappointed. In his live-update Direct Line "blog" this morning, Jeff Clark told S&A Short Report readers to expect a boring day...
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Don't expect much of anything to happen today. |
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The day before Thanksgiving has been higher for 8 of the past 10 years. So, the odds favor a little more upside. |
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Volume is likely to dry up completely after the first hour. So, there's really no reason to stick around. |
The Digest team also wishes you a wonderful day of turkey, football, and family... We're taking the day off tomorrow to celebrate the holiday. But we'll have a new Digest for you on Friday...
Yesterday, tech giant Hewlett-Packard proved once more why it's an excellent short-sale candidate...
Before we get into the events that drove the stock down 12% yesterday to a 52-week low, a bit on HP's troubled past... (It's cycled through three CEOs in two years, settling most recently on former eBay CEO Meg Whitman.)
We like to short three types of companies... ones with an unsustainable debt load... ones in obsolete markets... and frauds.
HP comes close to hitting the trifecta…
HP has an unsustainable debt load. The company has nearly $30 billion of long- and short-term debt on its balance sheet and total liabilities of around $85.5 billion. HP accumulated that debt by borrowing lots of money to make horrible acquisitions over the years (like desktop-computer maker Compaq and mobile-device maker Palm).
The company's single-largest asset is its $36.8 billion in goodwill. Goodwill is the premium over book value a company pays for an acquisition... HP conceivably overpaid for these acquisitions by $36.8 billion.
Compare that with the company's market cap of $23 billion.
While we can't say HP's market is obsolete, PCs are rapidly losing market share to smartphones and tablets.
No fraud has been exposed... But suddenly, allegations abound after the company's quarterly earnings release yesterday…
HP announced an $8.8 billion charge against its $11.5 billion 2011 acquisition of software company Autonomy. HP said it discovered "serious accounting improprieties, disclosure failures, and outright misrepresentations at Autonomy" during a seven-month-long internal investigation. Whitman said Autonomy made a "willful effort" to mislead investors.
At the time, Wall Street analysts thought HP overpaid for Autonomy... It's a reasonable assumption, based on HP's history of acquisitions. (In the previous quarter, HP lost a record $8.86 billion on a charge for its $13 billion acquisition of consulting firm Electronic Data Systems in 2009.)
But the bidding history for Autonomy confirmed that view...
Prior to selling itself to HP, Autonomy reached out to Oracle. But the software giant refused to buy the company for $6 billion (almost half of what HP settled on).
Unfortunately for HP, the bad news didn't stop with its Autonomy write-down... Revenue fell to $29.96 billion from $32.12 billion a year ago. And excluding the write-down, the company earned $1.16 a share, down from $1.17 a share a year ago.
In total, HP lost $6.85 billion for the quarter, compared with earnings of $239 million a year ago.
Some investors may consider Hewlett-Packard a "value play" at today's price... It's a globally recognized brand with a long operating history. But don't be fooled. HP is a classic "value trap." It has too much debt, it operates in a declining industry, and while there's no evidence of outright fraud (yet), we have serious reasons to doubt the company's management.
Short-selling master Jim Chanos, manager of the Kynikos Associates hedge fund, was short HP coming into yesterday's announcement. And he's still short today…
He appeared on the financial cable network CNBC this morning to discuss the huge write-down, which he predicted when HP originally purchased Autonomy. Coincidentally, Autonomy was one of Chanos' favorite shorts at the time…
Chanos said Autonomy was making lots of acquisitions and immediately writing down the value of those purchases. Without getting into the finer details of this questionable accounting practice, companies can write down an acquisition immediately based on expected future expenses related to that acquisition. The amount of the write-down is placed in reserves.
Then, the company can increase its earnings by writing down those reserves, saying the expenses weren't as great as expected.
In Autonomy's case, Chanos alleges the company would arbitrarily add extra cash to these reserves, which would in turn add more to earnings in the future.
It seems Chanos (among other analysts) and Oracle (which refused to buy Autonomy for $6 billion) clearly felt the company was being too aggressive with its accounting.
We doubt HP and its accountants missed this (and if they did, they're truly incompetent)... Its current accusations are more likely a desperate attempt to make itself look better in hindsight. HP made a horrible acquisition. Now, it's trying to blame someone else.
On a side note... This shows you how difficult it is to successfully sell short. Even though Chanos was correct about Autonomy, HP bought the company at a huge premium… and Chanos got crushed.
We dedicate a lot of time in these pages discussing America's shale gas and oil boom...
These huge stores of domestic oil and gas (unlocked by new technologies like horizontal drilling and hydraulic fracturing, or "fracking") will reshape the global energy landscape. The International Energy Agency estimates the U.S. will overtake Saudi Arabia as the largest oil producer in the world by 2020, for example.
The "shale boom" is one of the biggest economic trends of our lifetime... The sustained low natural gas prices it is creating (thanks to oversupply) will encourage alternative uses – like adopting natural gas as a transportation fuel. But the world must spend tens of billions of dollars on infrastructure before this revolution can take place...
Converting natural gas into reliable transportation fuel is challenging. The gas must be captured from deep underground… transported to collection hubs… condensed into liquefied natural gas (LNG)… transported again to fueling stations… then sold to the public. It's a complicated process, but one that will lead to huge profits for certain companies in the near future.
News agency Reuters reports General Electric sees LNG equipment becoming a $1 billion market within five years. GE has begun tapping into the natural gas megatrend through the sale of two "Micro LNG" plants (plants that process raw natural gas into LNG) to infrastructure provider Clean Energy Fuels (CLNE).
Many businesses expect to save at least 25% in fuel costs by converting their fleets of earthmovers, locomotives, ferries, and semi-trucks to run on cheap LNG fuel. And some companies are already switching over their fleets...
Wal-Mart, Coca-Cola, FedEx, UPS, and Waste Management are just a few of the major companies converting their huge fleets of vehicles to run on natural gas instead of diesel fuel. State governments – like the Texas Department of Transportation – and thousands of municipalities have started switching to the cheap, clean-burning fuel, too.
But our country doesn't yet have the infrastructure to support this shift. That's why we believe Clean Energy Fuels could soar as the natural gas boom continues...
Clean Energy Fuels, in partnership with GE, is building out a nationwide refueling infrastructure. It now has 70 LNG fueling stations along major interstates across the U.S. Within 13 months, it plans to have 150 stations. Right now, the company depends on gas-fired electricity plants to supply fuel to its stations. The power plants ship excess fuel not used for generating electricity to CLNE's fueling stations... but spikes in electricity demand often disrupt CLNE's fuel supply. Clean Energy purchased the new plants from GE to ensure its growing network of stations has an uninterrupted source of LNG.
Shares of Clean Energy Fuels popped 11% on news of the GE deal.
That's good for subscribers to Frank Curzio's Small Stock Specialist, which has the company in its model portfolio. Here's what Frank told subscribers about the purchase in a recent update...
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Under the terms of the deal, GE will provide up to $200 million in debt financing and receive warrants for the purchase. Once the warrants become exercised, GE will own about a 6% stake in Clean Energy. The new plants are expected to be completed by 2015. |
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This deal also shows that GE – one of the biggest infrastructure companies in the world – is betting big on "America's Natural Gas Highway." That's the build-out of LNG fueling stations across every major highway in America. And it's a key aspect of our Eagle Diesel investment thesis. |
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Each passing quarter, we see major trucking companies announce they are switching from diesel engines to natural gas. That's because the cost savings per gallon are over $1.75. |
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To put some numbers on this trend, it costs about $30,000 to convert the average truck from diesel to natural gas. At current prices, however, the cost savings per year once this switch is made is about $27,000. That means after one year, trucking companies can start making massive returns on their investments. |
The savings are so great because natural gas is so cheap compared with oil. Take a look at the chart below from the U.S. Energy Information Administration. It compares natural gas versus oil on an energy-equivalent basis. It cuts down to the "nitty gritty" of each fuel's cost for every horsepower of energy produced.
From the mid-1990s through 2009, gas and oil costs fluctuated in a range relative to each other that made capital investment in mass conversion unattractive.
Beginning in 2010, you can see how much cheaper gas became compared with oil... Today, natural gas prices have fallen so far, it's more than 80% cheaper to burn than oil. We expect this discrepancy to last for years... And we expect companies will rush to convert their fleets to the cheaper fuel...
It's not just commercial fleets making the conversion, either. Chrysler began allowing dealers to take retail orders for its natural-gas-fueled Ram 2500 pickup truck in September. They should hit the road early next year.
No one in the financial publishing industry has written more about the shale boom than Porter. He recently published a set of three special reports examining all the facets of the megatrend… Among them, his report "Cornering the World's Next Trillion-Dollar Business" details the infrastructure plays that stand to skyrocket as new uses for natural gas proliferate…
The wealth this energy boom will create is so great… Porter predicts it will have incredible consequences on more than just the U.S. economy. He says President Obama will use the political influence it gives him to hold on to power past 2016.
To read more about Porter's work on the energy boom and how it's reshaping America's economic and political landscape, click here. (This will not take you to a long promotional video.)
New 52-week highs (as of 11/20/12): Prestige Brands Holdings (PBH).
If you're in a cold part of the world right now, come visit Nicaragua with us next month... One subscriber is hooked. Send your feedback to feedback@stansberryresearch.com.
"For a few years now I have been an Alliance member and first learned of Rancho Santana through you. A week ago I returned from spending time there and became a property owner in the process. The place is amazing... no pictures can do it justice. I just want to thank you for making the introduction. In time I expect to build an awesome home with a breathtaking view. Hope to share a drink with you in the clubhouse sometime." – Paid-up subscriber Steve Morse
Goldsmith comment: We're taking a small group of subscribers to Rancho Santana December 12-16. I wrote about the trip here. The trip is almost full. If you'd like to attend, please e-mail Rancho Santana's head of sales, Marc Brown (marcb@ranchosantana.com).
"Yesterday, Monday, 19 November 2012, I received an e-mail from Porter Stansberry regarding the hellish nightmare that Comrade Obama may serve a third term. Unfortunate when I went back to read it again I can't find it. Would you be so kind to advise me as to where I can find this e-mail." Paid-up subscriber James E. Henley
Goldsmith comment: You can watch a video Porter's recorded, detailing his prediction of Obama's third term, here.
Regards,
Sean Goldsmith
New York, New York
November 21, 2012