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Friday, November 21, 2008

Irrational exuberance

I was just watching Bloomberg TV and they showed a chart of the S&P and had the "irrational exuberance" speech noted on the chart. It was in 1996. The S&P was 744 at the time. Last sale on the S&P is 755. And that's the problem with a bottom here. From 1929-1932 the Dow retreated 90%. I don't know if that's what we're looking at but I do know that this is an almost unprecedented bear market. Frankly, 1929 is the only precedent I have that has any parallels to what's happening now.


Anyway, the last week or so... specifically since Paulson told us he's not going to buy bad paper with the TARP funds (which is what they were for - way to inspire confidence, guy), the commercial mortgage backed securities market has imploded. Credit risk spreads have exploded higher as investors have concluded the bailout will not spare them. Consequently, as credit default swaps have become the tell for stocks, the reit index has gotten demolished.

This goes back to my point about hand-picked bailouts. If the system is broken, you have to fix the system, not the worst examples of it. As a result of saving AIG, hundreds of lesser companies that won't get anywhere near the TARP funds will die. Ultimately, they can't stop the unwinding process and by interfering, they merely shift the consequences to other entities. The plugs will just force new leaks. The insurance companies have been cut in half as the S&P broke 900 -- all of their annuity portfolios are pegged to 900 apparently and the liability becomes open ended as the market goes lower.

Regardless of the government's efforts to constrain and contain it, the market wants to be free and will liberate itself to the downside until it gets its due. Sadly, we will all pay for the risk transgressions of the last several decades.

SEC to discuss mark to market accounting

The SEC has a panel discussion today on mark to market accounting. Obviously with the marks to market driving major financial institutions into default, there's a big lobbying force that would like to change the rules.

Changing the rules would further obfuscate the problem. The main problem in a credit crisis is confidence. By changing the rules, an element of disbelief will continue to pervade perceived other party risk. If you have 10 things that are trading for 5 and you say they're worth 10 anyway, I don't care... they're worth 5, you delusional fool. I'm not going to give you credit on that basis. In fact, it's going to make me even more suspect of the other 100 you have because I know they're probably worth less too.

The fact of the matter is these credit problems were brought about by over-leverage. Margin requirements need to be raised to restore confidence to the system, not lowered to enable broken portfolios to survive... but raising requirements would be a death knell. Instead they want to try to soften the blow and call insolvent solvent.

All of these efforts to lessen the downturn will only elongate and exacerbate the situation. Cycles have to play out to complete.

Novellus (NVLS) orders crash

On their mid-quarter update Novellus lowered order guidance to down 25-35% versus prior guidance of up 5 to down 15% for the quarter. Memory orders utterly fell apart as the sinking DRAM and NAND markets force memory manufacturers into cash conservation mode. Furthermore, their Europe-centric industrial manufacturing business got dramatically weaker in the last couple of weeks. Revenue and gross margin forecasts are also coming down as orders are tanking. Novellus suggests the industry is getting to maintenance levels of business. I would posit that in a downturn this severe with so much oversupply on the way in, balance sheets so weak and the financing markets shut down that the semicap industry will not bottom until some Asian manufacturers go belly up.

Novellus trades at a little over 2 * cash.

Dell and the outperformance

The company chose to walk away from unprofitable business and held back on price cutting. This was a strategy that Rackable, admittedly a smaller player, tried when business first slowed down for them. It worked for a quarter and then the top line collapsed.

There was a one-time bonus accrual reversal that added 170 mil (3 cents) to operating income. Nonetheless, Dell showed impressive expense controls in the quarter. I still think business goes south for a while and that operating income will be under intense pressure over the next couple of quarters. Their first crack at the adversity is very impressive, though.

Dell suppliers are clearly getting the hot end of the poker here as Dell is a notoriously tough negotiator when it comes to components.

Thursday, November 20, 2008

Dell 3Q:2009 results

Revenues significantly worse than expected at 15.2 billion offset by higher gross margins and tight expense controls, leading to 6 cents of upside for the quarter. Component prices clearly are coming down very rapidly or there's something funky in there distorting the number. It's surprising (suspicious?) that they have that kind of dynamic control of the P&L. I took off the small short basically flat from the sale because I'm scratching my head on how they made all that money on that kind of top line shortfall. No guidance except corporate will remain challenging.

Maybe I'll get to short it at $11.75 after all.

Also surprising in the release is the comment that they bought back 21 million shares for 400 million dollars in the quarter. I guess they've never heard of VWOP -- their average price close to $20 with the stock at $10.

More after the call.

Make or break

A few weeks ago I got attacked for posting this chart.

So here we are. This is the only real potential bounce level between here and 6000.

DRAM prices continue to tank

For the second half of November average DRAM contract price was negotiated down 9-10%. The combination of a frugal consumer, a declining PC market and massive insolvency in the DRAM manufacturer base continue to weigh on memory makers. Furthermore, the only strong part of the PC market is the netbook market and those come with 1 gig of memory, far below the industry norm of 2 gigs... so all the unit growth in netbooks actually has a negative effect on DRAM consumption.

Micron under $2. Not pretty.

Dell 3Q:2009 tonight

Don't expect much help from Dell tonight. I'm not discovering America when I suggest revenue is likely to be below consensus. More concerning with Dell, though, is the operating leverage and their reliance on a relatively quick turn cycle to generate margin. A couple of weeks ago I posted an item from a local paper saying Dell was trying to get employees to take unpaid vacations (or lose their jobs). The economy isn't getting better and presumably won't for some time. Dell has an October quarter end which means they had to slog through seasonally weak August, and the September and October shock months. I have no sense of whether visibility has improved in November but it sure doesn't feel that way. The NPD data was somewhat better for October than I'd expected but I think that benefits Dell only in the retail channel where they sell a less profitable sku. Dell is a major player in the supply chain, there's lots of weakness there and it's not coming from HP or Apple.

I would very much like to be wrong about this and see Dell report an okay number so I can short stock higher as I expect a dramatic curtailment of their model is coming over the next couple of quarters. Operating margins could get cut in half. A few days of unpaid vacation isn't going to avert layoffs here. They've got sales infrastructure to support 65 billion of revenue in an industry under constant price pressure that is now shrinking and forecast to decline further over the coming year.

In the past, Dell has garnered a premium multiple due to their anticipated growth and presently their stock is getting a discounted multiple due to their anticipated shrink. The stock at $10.35 trades at 8 * 2010 estimates. My guess is that 2010 estimate is going to get cut in half by the time we get halfway through next year and that Dell is probably trading at closer to 16 * what they'll actually report. The chart is rotten and I can see the stock at $4 (that sounds so crazy I want to delete it).

I'm not sure what the stock is going to do on an anticipated miss. I was going to short stock at $11.75. I was short the stock recently but took it off when I covered all my tech late last week -- these valuations are confusing me in all honesty. Dell looks cheap if you believe the estimates that support it -- I don't, but I'm not the only one as the stock's got a shrinky multiple.

11:40am -- I shorted a little. Just a little. I'll sell more at 11.75 if it gets there... or maybe after the number.

Tuesday, November 18, 2008

Hewlett Packard (HPQ) guides

HP is guiding revenues and eps for the current quarter better than street consensus -- about 500 mil better on the top line and 4 cents better on the bottom. I'm surprised they're not seeing more of a slowdown.

The full year 2009 outlook is 5.0 - 7.5 bil below the consensus of 135 billion but the non-gaap earnings guidance is higher. As the stock trades at roughly 7* next year's earnings number as of last year's close, it's up over 10% in pre-market trading.

Tech could rally on this. I wouldn't step in front of it yet -- they have room to move higher. The SOX around 200 is compelling for longer-term players and the consensus in tech is decidedly negative. I don't have much tech short exposure presently.

I'm going to be offering Dell short at 11.80 as I think they're seeing more impact from a slowing consumer than HP. I'm also going to be scratching my head and wondering how HP is doing it.

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