Einhorn's latest short... Eifrig's good call... Chanos' value traps... Cooperman's hot list... Goldman's big loss... Was Bush a socialist?...
The highlight of our first day at the Value Investing Congress in New York City was famed hedge-fund manager/author David Einhorn's presentation on his latest short sale idea: Green Mountain Coffee Roasters (GMCR).
Green Mountain bulls say the company has an effective razor-blade model. It sells Keurig coffee machines at cost and then sells high-margin "K-cups," the little single serving pods of coffee that only fit these machines. Also, coffee brewers license the K-cup technology so they can make K-cups with their own brand of coffee, tea, cider, or other drinks. Bulls love that Dunkin' Donuts and Starbucks have signed deals with Green Mountain to sell their coffee in K-cups.
The stock was a near four-bagger during the past 52-weeks, running from a low of $29 to a high of $115.
My wife and I are convenience junkies. So naturally, we have one of these machines. We love it. I never drank much coffee until I got a Keurig machine. It's so easy to pop one of those little cups in the top of the machine and press the brew button. About 10 seconds later, I've got a cup of hot coffee...
But as Einhorn informed us yesterday, Green Mountain's K-cup patents run out in September 2012. When that happens, Green Mountain will lose its ability to charge premium, monopoly prices for K-cups. K-cups suddenly become a commodity, a much less valuable bit of technology that carries your favorite brand of coffee. The content, the coffee brand inside, is the valuable part, not the K-cup container. You don't say, "I love K-cups." You say, "I love Starbucks coffee" or whatever your favorite brand happens to be.
Green Mountain is loaded with other problems, too. It acquired several businesses at outrageously expensive valuations and has written down the value of goodwill and intangibles from those acquisitions by more than the total purchase price of the businesses. Einhorn is right to be suspicious of this.
Einhorn noted the demand for K-cups was falling over the last several quarters... until the most recent quarter, when it spiked up sharply – something else he found suspicious. He then told us nightmarish stories about how this may have come about, based on interviews with former employees of the Green Mountain distribution arms. Einhorn said ex-workers told him they'd be asked to fill up a truck with coffee and deliver it to the other end of the same building. Others told stories of emptying half a warehouse, taking inventory on the remaining half, then putting the other half back.
Overall, Einhorn criticized the company's financial disclosures, saying that it changes its presentations so much every quarter, it's hard to get an idea of what's going on. He also says capital spending is growing faster than the overall business and management is "vague" about how it's really spending the money.
I can hardly do justice to Einhorn's 100-plus-slide presentation here. The guy obviously does deep research… traveling around the country and talking with everyone who might be able to shed some light on the business. His presentations always make me feel like I'm not working nearly hard enough...
The stock closed down 10% during the day. And as Einhorn began the Q&A period, it was down more than 13%. It's down another 3% today.
Before we discuss yesterday's second great presenter, I must give props to Doc Eifrig… We dropped our bags in his hotel room before dinner. "I want to show you something... You'll be my proof," Eifrig said as he started rummaging through his bags. After sorting through a half-dozen scraps of paper, he found what he was looking for... a torn page of Barron's with "Long Starbucks, Short Green Mountain" scribbled on it. He came up with the idea on his way to New York. Too bad… he was a day late.
Jim Chanos, the short-selling founder of Kynikos Associates, also gave a stellar presentation. He warned investors to avoid "value traps" – stocks that look cheap, but are actually flawed and declining businesses. Chanos outlined his China short – one we've covered often in these pages. We'll focus on two others today…
He warned investors to avoid "liquidating trusts," particularly integrated oil companies. Chanos noted oil exploration, development, and production costs have soared... Finding and developing a barrel of oil cost $5 in 2000. It costs $22 today. Production costs are up from $5 a barrel to $15 over the same period. As integrated oil moves to natural gas production, the price of gas will plummet with availability. In particular, Chanos mentioned his ExxonMobil (XOM) short. He said the company's reserve replacement ratio was inflated due to its XTO purchase. Also, Exxon had $25 billion of net cash at the end of 2007... Now, it has net debt of $6 billion.
The second value trap Chanos discussed was businesses switching from physical media to digital distribution. Companies selling CDs and DVDs have taken a huge hit. Chanos says GameStop, a videogame retailer, is next. He said the stock is "cheap," but it will be "cheap all the way down."
Leon Cooperman, a longtime Goldman Sachs employee turned hedge-fund manager, was the first presenter this morning. He's bullish. He says stocks are cheap based on history, inflation, and interest rates. He also said he "wouldn't be caught dead" owning Treasury bonds. We're currently experiencing negative real interest rates (when inflation is greater than the risk-free yield). Leaving corporate debt and stocks as the two remaining asset classes, he believes "stocks are the best house."
He said he could have put up hundreds of stocks he likes right now. Instead, he put up a list of 10. Today, he likes consumer electronics giant Apple, medical devices giant Boston Scientific, global investment firm KKR Financial (which yields 9.5%), Transocean shipping line, and online brokerage E*TRADE.
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New 52-week highs (as of 10/17/11): AltaGas Income Trust (ALA.TO), MSDW Insured Muni Income Trust (IM), short of First Solar (FSLR).
In today's mailbag... Our subscribers do speak English... And was President Bush a socialist? Send your queries to feedback@stansberryresearch.com.
"I just want to comment on subscriber Walter Jacque's email… This is not the first time I have read of a member complaining about something, but it is the first time I've read an accusation of fraud against S&A. I have been with S&A as an alliance member for several years now. One thing I can say for sure is S&A is not a fraud. They provide a valuable service to their clients. If for any reason you are not happy with their service they will give you back your money. I never heard of a fraudulent business doing that!
"Call them up and straighten it out!" – Paid-up subscriber Luis Anderson
"Porter. I write and speak English. You don't seem to accept criticism from your subscribers very well. Sometimes your unhappy subscribers have a valid point but you get overly defensive and abusive with your responses. Ah well, at least you are willing to print the criticisms that you so rudely respond to." – Paid-up subscriber Doug Laubach
Porter comment: We're the only publishers we know of, anywhere, that routinely publish ALL the criticism we receive. We respond to most of it in a way that shows our appreciation for the information, which helps us improve our business. Without the feedback we receive, there's no way I could do my job as publisher. What we don't respond to kindly is deliberate attempts to misrepresent our work.
"How does an eye surgeon like Dr. Eifrig get his education in vitimin E? Is it part of his medical schooling or possibly from another doctor who did study it or maybe from his own personal research on it? It is true that there is a war going on to end the right to purchase supplements without a prescription and I for one do not trust the FDA at all. I believe that they are a corrupt institution that has been bought out by big pharma." – Paid-up subscriber Bob Warren
Porter comment: We don't trust the FDA. Nor do we trust folks who make a living pushing vitamins. Nor do we trust folks who peddle newsletters that claim to be independent, but are actually fronts for vitamin makers.
As far as Doc's credentials go... you simply can't say that a man who was a top prop trader at Goldman and then decided to become a medical doctor isn't a pretty smart guy.
And... unlike the FDA (which protects Big Pharma companies) or guys pushing vitamins, Doc gets to actually write what he believes. He's got no drugs or supplements to sell. Find another doctor out there who can say the same.
"In your recent newsletter, in the introductory paragraphs, you make the following assertions:
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The Western world is broke. It became that way by indulging in a whole series of socialist programs – such as: |
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Various banking rules encouraged reckless lending to peripheral governments whose credit profiles were falsely enhanced by membership in the euro. |
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... The U.S., which had been the largest creditor to the world, has become the largest debtor in history. Even today, its federal government continues to borrow more than $1 trillion a year, in order to maintain a military budget that's already larger than what the rest of the world combined spends on its military and a medical establishment that consumes almost 20% of GDP, more than twice what any other developed nation spends on health care. |
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This is financial insanity on a scale the world has never seen before. And rather than making any substantial changes... we've addressed the financial crisis by borrowing more and spending more. |
"Please... How do you rank these activities as socialist programs?
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– Wasn't it Bush that promoted the reckless spending policies for Housing etc.? |
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– Wasn't it Bush that cut regulation of the Financial industry at every opportunity? |
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– Wasn't it Bush that continued to up the spending for the Military as he took the US into two disastrously expensive wars? |
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– Wasn't it Bush that introduced Medicaid – free drugs for all seniors? |
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– Wasn't it Bush that bailed out the big financiers, Wall Street, including all the major EU banks – and converted US private debt to US public debt. |
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– And all with reduced taxation, especially for those in the upper decile of incomes. |
"Was Bush II a Socialist?" – Paid-up subscriber Geoff Davies
Porter comment: Who would argue that he wasn't?
Dan Ferris and Sean Goldsmith
New York, New York
October 18, 2011