Dubai gets bailed out… sort of

Abi Dhabi decided to bail out Dubai, by providing a $10 billion equity injection. This was presumably after the insiders bought back a ton of Dubai debt (which was trading below 50 cents on the dollar and post-announcement is around 70 cents). About $4.1 billion of the equity injection is earmarked for repayment of maturing Islamic debt, while the other $5.9 billion is going toward paying contractors and other working capital needs.

My quick guess is that the Islamic debt gets paid off first to avoid any judicial inquiry on what happens to investors in such debt – i.e. whether they will get a stake in a reorganized company. The conventional debtholders (where there is an active secondary market) are going to be at the mercy of the Dubai courts; I doubt they will be getting any favourable treatment. Maintaining the perception of confidence in the Dubai debt system is crucial for Dubai if they are to retain any foreign institutional investors, and inevitably whatever settlement coming out of the Dubai debt default will be precedent-setting.

I decided to look up what Islamic Debt was, and the Wikipedia entry on Sukuk was rather enlightening – it seems that it has characteristics of zero-coupon debt. That said, I have no idea who would ever want to invest in such financial instruments – at least when investing in Canadian or US debt instruments, you would likely have a better chance in bankruptcy court than you will in Dubai (General Motors notwithstanding!).

(Update: Apparently this is not an equity injection, it is debt.)

FairPoint – the only bankrupt company I ever had money in

FairPoint Communications was spun off of Verizon a year and a half ago. It mainly consisted of Verizon’s rural landline businesses. They carved out the company and distributed shares to Verizon shareholders. Since at the time I had money in the Telecom HOLDR, I received a distribution of one share of FairPoint.

There was no point in selling the share – it would have cost me nearly as much in commissions as the share price. My only hope was that management would be smart and do a tender offer for small lot owners (e.g. 10 shares or less) which would relieve me of the burden of receiving useless amounts of paper concerning voting for the board of directors, etc.

The company had way too much debt when it was spun out of Verizon, and a year and a half later, it has filed for Chapter 11. I look forward to my 4.5 cent piece of paper reorganizing and vanishing out of my account.

So far to date, this is the only company that I have held shares in that went bankrupt. All other companies I sold well before their Chapter 11 filings.

FairPoint is a viable operation; it just needs to reduce its debt by some 70-80% in order to be financially sustainable. Considering that most of its debt was inherited from Verizon (Verizon decided to take a $1.2 billion dividend out of it before spinning it out), one would think that they would have known that leveraging the company before giving it away would have killed the equity holders.

China will be sucking the world’s crude supply dry

The title is a one-line summary of what I will be describing in this post. Essentially with the global economic downturn slated to moderate due to the injection of fiscal stimulus, the countries that will continue to face true organic growth will have a need to consume more energy.

There is no economy on this planet growing faster than China, and not surprisingly, one can see from this article that their actual crude consumption has increased, and will continue to increase in the future. Note that Japanese consumption continues to decline, which is lock-step with their economy.

The only two questions that need to be answered is whether North American consumption will decrease and where will the supply come from?

I will borrow a slide from R-Squared (who incidentally knows much more than what he discusses on his blog, and knows much more than your typical politician on the issue of alternative fuel sources) and just say that the supply side looks to be capped in the future:

Slide04

Since world oil production has probably peaked, or is close to peaking, any supply-side shocks will have a disproportionate amount of impact in price. It is likely that an absolute floor for crude is $35 as seen in late 2008, in the middle of the economic crisis. It is also more likely in ‘regular’ times that the floor for crude prices is higher, likely around $60 per barrel.

Marginal costs for alternative energy sources are still much higher than the price for crude extraction and processing; most of the inputs for alternative energy sources (e.g. corn ethanol) rely heavily on other energy inputs (crude and natural gas).

The only thing that will make alternative energy more viable is higher crude prices. And higher is where crude will go in the medium term. As crude’s price continues to go higher, more and more supply sources start to become economically viable. There won’t be a shoot-up to $1000 a barrel (barring some sort of global conflict) but a climb in prices is inevitable given the demand-supply dynamics.

The only salvation against higher crude prices are energy breakthroughs in other fields, such as the development of sustainable fusion, or less capital expense intense solar energy, or the development of high capacity low-loss energy storage.

What ever happened to Menu Foods?

Menu Foods was a company that ran into a huge amount of trouble for distributing pet food that contained Melamine, which caused kidney problems in pets, sometimes leading to death. The first precautionary recall was in March 2007 and then it took another month for them to isolate what exactly was causing the problem. It was through a supplier, ChemNutra Inc., who used wheat gluten that was imported from Xuzhou Anying Biologic Technology Development Co. in Wangdien, China. The whole history of the case is documented on the company’s website here.

These series of events took the company’s units from seven dollars a share to about one dollar less than a year after the news broke. Financially, the company is not on solid ground – although it was somewhat profitable before this incident (making about $24 million in distributable cash in calendar 2006), its balance sheet was quite leveraged, with a net debt of about $100 million.

Fast forward a few years, it still has the debt – some $105 million. The only difference is that $75 million matures in October 2010. The company breached its covenants in 2007 (primarily due to the aforementioned recall) and as a result had to cut its distributions to zero and pay its creditors a rate of LIBOR plus 5.8%.

Lately, however, the company seems to have recovered from its near-death experience: they have settled the lawsuit, and they are now generating cash again – about $11.1 million in free cash in the first 9 months of 2009. Their units, in response, have gone up from about 80 cents at the beginning of the year to $2.50 currently; at 29.3 million units outstanding, that is approximately a market value of $73 million.

The primary hurdle for Menu Foods at this point seems to be the renegotiation of their $75 million debt. If they can achieve this, then unitholders will be sitting pretty and perhaps distributions could continue after they have continued to deleverage their balance sheet. It is interesting to note that a company that was originally on its deathbed is now positioned to survive, in no part due to investors’ risk preferences being expanded in the zero interest rate environment.

A quick look at the top 10 Nasdaq stocks

The following is a very superficial look at the top 10 capitalized companies trading on the Nasdaq (not the NYSE), their market capitalization, and the P/E based on the next fiscal year’s analyst consensus estimates. Also added in are some very quick notes on the respective companies. In order for the index to rise, the top 10 usually must rise as well. I typically do not invest in large capitalization companies because you implicitly are giving up an advantage as a small investor that most large investors do not – the ability to be nimble and build substantial positions in small companies.

Amazon – $58B – P/E 53, pricing in INSANELY high growth, both top line and margins
Amgen – $57B – P/E 11, patent expiration on Epogen coming soon
Apple – $170B – P/E 20, lock on the digital music market, perhaps not the hardware side though, probably under-valued amazingly enough.
Cisco – $139B – P/E 15, essentially a ‘commodity’ network hardware company now
Comcast – $49B – P/E 14, boring cable company
Google – $186B – P/E 22, profiting on any mouse clicks on the internet, decimated traditional media, probably has reached upper end of scale.
Intel – $112B – P/E 14, commodity CPU maker
Microsoft – $264B – P/E 14, commodity OS maker, eroding margins from open source software
Oracle – $113B – P/E 13, commodity DB maker, same thing as Microsoft (they really should merge)
Qualcomm – $75B – P/E 17, basically half the cell calls on the planet (CDMA) make a profit for this company