The S&A Digest: Barron's on GM

Barron's on GM... More Chinese inflation... Klarman on distressed debt... Last chance for True Income... H&R Block soars... Merrill sells the family silver...

We're not the only analysts on the GM story anymore. In this weekend's Barron's, Randall Forsyth notes in the opening essay: "GM stock actually traded as low as $11.21 Thursday, a depth that hadn't been plumbed since 1955, when the Dow was in the 400s..." Our prediction? It will go lower still.

A sign of the times? The Chinese now own the annual lunch with Buffett. Chinese hedge-fund manager Zhao Danyang, manager of Pureheart China Growth Investment Fund, won this year's annual charity auction. He paid $2,110,100 to have lunch with Warren Buffett in New York. Buffett started these charity lunches nine years ago. The first three, not listed on eBay, brought in $18,000-$25,000 a piece.

While we probably wouldn't pay $2.1 million to eat lunch with him, we still greatly respect Seth Klarman. His deep value hedge fund, Baupost Group, smashes the market every year while holding up to 50% of its assets in cash. Klarman recently did an interview with Institutional Investor, where he described what he's buying now:

Distressed-debt investments where we own the senior debt. That is a favorable place for a value investor. You have a margin of safety since, as things go bad, people who are junior to you are the ones who lose value before you do. Second, the bankruptcy process itself is a catalyst. A cheap stock can stay cheap forever, but if you own a bankrupt bond, the process of emerging from bankruptcy and distributing new securities offers a practical catalyst to realize the value.

That's the same basic strategy we're following in our newest publication, True Income. By carefully analyzing the assets of "distressed" corporate bonds, we're buying deeply discounted securities where we have both a substantial margin of safety and a reasonable expectation of 100%+ returns.

Few individual investors have ever considered buying individual corporate bonds. Fundamentally, there's no reason not to. It's simply that when it comes to investing, most people only think about buying stocks. As far as we know, no other investment newsletters cover only corporate bonds. This gives us a big edge. There simply aren't many other investors studying these bonds. We have the whole space nearly to ourselves. And that makes it much easier to find great values.

If you're a serious investor, you should at least keep an eye on the corporate bond market. From time to time, you'll find truly exceptional opportunities. If you're interested in seeing our letter, I recommend you subscribe now. After tonight, our charter subscriber offer expires, and the price will double.

Extreme Value pick, H&R Block (HRB), the biggest U.S. tax preparer, reported its first quarterly profit in two years after selling its loan-servicing division to Wilbur Ross. The company increased its annual dividend by three cents a share to 60 cents and announced a $2 billion share repurchase program. Shares are up about 4% today.

Merrill Lynch needs money. And to raise it, the bank is selling its 20% stake in Bloomberg LP. John Thain, Merrill's CEO, says its stake is worth $5 billion to $6 billion. Bloomberg is thinking more like $3 billion.

Bloomberg is a fantastic business. In our opinion, it's the premier financial media company. And its research device, the Bloomberg terminal, is an integral part of every research analyst's repertoire. The terminal costs $1,800 a month ($21,600 a year). If you have two terminals, the company reduces the cost to $1,500 a month ($18,000 a year). Bloomberg offers no volume discounts... every terminal after the first is $1,500 a month. There are approximately 250,000 terminals worldwide.

If you've ever walked onto a Wall Street trading floor, you'd know how valuable these terminals are. Every trader and analyst has one... and the bank pays the same subscription rate for each terminal.

To give you an idea of how highly regarded these terminals are, one value-fund manager told his analysts he would raise their individual bonuses by $15,000 if they would forego their Bloombergs. Eleven out of the 12 said no. One analyst said he would rather see his current bonus cut by $15,000 than give up his Bloomberg.

So why would Merrill Lynch ever sell its stake in this cash-producing machine? It's probably the last good business it owns.

New high: Anheuser-Busch (BUD).

In the mailbag... Alert the media. We're accepting the blame. Send your comments to: feedback@stansberryresearch.com.

"Your S&A Oil Report recommending ATP Oil & Gas was a disaster! They are now losing around 25%. If I had realized this outfit was virtually all Nigerian in operation I wouldn't have invested in it. No doubt you will claim that the S&A Oil Report is another branch." – Paid-up subscriber Sefton Samuels

Porter comment: No, not at all. If my name is on the publication, then I publish it. (Frequently we receive angry letters accusing us of bad advice about stocks we've never even heard of before, and certainly never recommended. Likewise, we often get angry e-mails regarding publications we don't own, manage, publish, contribute to... or even read.)

While I'm not familiar with the details of ATP Oil & Gas, I do know our oil analyst, Matt Badiali, has had a spectacular run, with dozens of hugely profitable recommendations. That he got tripped up on one stock because of the chaos in Nigeria is unfortunate... but not wholly surprising. Nobody bats 1,000. While I certainly regret your losses, I hope you'll consider the overall results Matt has achieved when forming your opinion of his work.

"I too Q your claim GM is headed for BK; let me give you some comparable examples where absurdly low prices WERE bargains – not harbingers of BK; Chrysler 20 years ago was at $3; McDonald's less than 10 years ago bottomed at $12; Apple 7 years ago bottomed at $9; and Philip Morris was paying a 10 pct dividend when it traded at $20 6 yrs ago – only to triple before the spinoff. Like Chrysler & Bear Stearns, GM is too big to fail; it will merge like Chrysler or be bailed out somehow..." – Paid-up subscriber Gary Peter Klahr

Porter comment: The difference between GM and most of the examples you cite is a truly enormous pile of debt obligations – something you didn't see at McDonald's, Philip Morris, or Apple. Like it or not, the only way for GM to continue operations is for it to declare bankruptcy. Freed from onerous union obligations, pension expenses, and a $5 billion annual interest expense, GM could once again become a great corporation. Its debtholders should be made whole through equity in the new corporation. But its existing shareholders will be wiped out.

"As a child in the Great Depression my life went from homeless to bare existence on a farm without electricity or indoor plumbing. At 18 I volunteered for the Army and was assigned to the medical corps, spending the war years in England and Europe. After discharge I used the GI bill to finance my way through Med School. After a year of internship in Miami, Fla. I had no money to set up a medical practice so I joined an invalid surgeon and he supplied the infrastructure while I did the leg-work. Three years as a general practitioner, and I was ready to specialize. After a 3 year residency at the University of Chicago I became a Board Certified Dermatologist. Now again I had no money to set up an office. After some false starts I joined the Permanente Med Group Kaiser of northern Cal. They took care of the business and I took care of the patients. Now for the first time I had money to invest so I bought a few stocks recommended by a broker. But it was the 1970's and stocks went nowhere. My neighbor was an Indian immigrant teaching Economics and moon-lighting nights selling real estate. With my money and his expertise we started buying cheap real estate. We only sold to trade up. I remember going to the Bank of America for a $300,000 mortgage loan. I thought they were going to call the police. An S&L gave me the mortgage. My Indian partner managed the rental properties, we invested the proceeds, Cal real estate appreciated in value and we became multimillionaires. So at the age of 60 I decided to retire. Kaiser gave me a very generous retirement package which included a pension, and total medical insurance for life. I did some travel, some volunteer work, some charity work, started stock market investing, gardening, restoring old Victorian houses... and taking my blood pressure, popping pills etc. Now at 85 I go up these 3 flights of stairs very slowly, and have a housekeeper. My heirs and University Alumnus offices have never been more attentive. What more could a guy ask for. My Indian partner dropped by recently. He said, 'You have been one of the very few friends I have had.' I would like to be remembered that way." – Anonymous

Regards,

Porter Stansberry

Baltimore, Maryland

June 30, 2008

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