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Weekend Edition

The Best of The S&A Digest
Saturday, March 14, 2009

I began writing about the inevitable fate of highly indebted companies in late 2008, when it became obvious the credit markets for high-yield debt could not be repaired. In my newsletter PSIA, I published a list of companies that were certainly headed for bankruptcy. The average loss of those stocks is now about 40% – in only three months.
 
In particular, I explained that if highly indebted mall owners Macerich (MAC) and General Growth Properties (GGP), could not earn enough money to pay their interest expenses in good times (2007), they were certainly going to zero. No one would refinance a corporate borrower that's upside down on its debts and can't afford its current interest payments.
 
A chorus of boos erupted from my subscribers when shortly after I published my comments, both companies released news essentially refuting my analysis. So... who was telling the truth? Well, General Growth is down 75% over the last three months. Macerich is down nearly 40%.
 
Every single company I've recommended short selling has lied left and right – to journalists, to their investors, and even to Congress. Look at what the CEO of Gannett said about his firm's huge writeoff just before I recommended selling it short:
 
"This is an accounting event – and I stress accounting event – that I believe needs explaining. Let me begin by assuring you that the company remains healthy. This charge will not hold us back in any way: We can pay our dividends and our debts, make strategic acquisitions and investments, and repurchase shares of our stock."
 
That was as bald-faced a lie as any corporate executive has ever told. Gannett's revenues were plummeting. It can't afford to repay its debts. And it obviously would have to cancel its dividend, which it reduced by 90% in February.
 
Even though the stocks I outlined in PSIA are already down about 40%, there's still plenty of room for them to fall. In fact, I think they're all going to zero... And you know I don't throw that term around recklessly.
 
We call stocks like these "roadkill." They may not be all the way dead yet, but someone should do them a favor and put them out of their misery.
 
Warren Buffett hates airline stocks. He bought a preferred stock issue from U.S. Air in 1989. By 1995, the company had lost $3 billion, and Buffett's preferred dividend was suspended. Since then, he has been very vocal about his feelings toward the aviation industry.
 
"The net wealth creation in airlines since Orville Wright has been next to zero. If a capitalist had been at Kitty Hawk and shot him down, he would have done us a huge favor... The worst sort of business is one that grows rapidly, requires significant capital to engender growth, and then earns little or no money. Think airlines."
 
But... knowing the airline industry has always been a loser for investors makes airline stocks very easy (and safe) to sell short. In fact, right now, you can easily find a half-dozen airlines that cannot afford the interest on their debts, suffer from plummeting revenues, and face huge losses related to commodity hedging. (Need help finding one? See my latest issue.)
 
From a reader: Could you review the ins and outs of shorting a stock? What are the risks?
 
I've been recommending shorting stocks each month in my newsletter, PSIA. There are so many companies with overleveraged balance sheets. These stocks can't afford the interest on their debts, and they can't refinance or raise new equity in this market. There's no way they can escape bankruptcy, which wipes out the value of their stock.
 
In these situations, shorting stocks is actually the safest investment you can make.
 
In my most recent issue, for example, I covered a stock that's losing $400 million per quarter in cash. It is down to its last $2.6 billion in cash. And when the company's cash balance falls below $2 billion, it will trigger various debt covenants and cause the firm to file for bankruptcy.
 
The company also has a $400 million loss outstanding on a derivative contract. (It's perfectly hedged, as I like to say: It will go bankrupt no matter what happens in the future.)
 
Regards,
 
Porter Stansberry




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