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Well, I was wrong.

Overstock reported, and they missed the Street’s operating income number by 50%, coming in at a $6 million loss versus the Street’s $4 million-plus forecast.

In true Patrick Byrne fashion, of course, Overstock masked the bad news by including a one-time $4 million gain in the reported number—making no mention of the gain in the press release discussion of income items, as far as I can see.

Rather than include the $4 million one-time gain in the headlines or the introductory paragraph, it is buried at the bottom of Patrick’s list of “mud-pies and cream-pies,” which never seem to go stale at Overstock.

They just keep baking more.

The CEO’s letter is, of course, full of the usual technology-heavy nonsense Byrne likes to employ when he wants to keep attention away from the business itself, which is slowing and losing money.

But if you read carefully you will see that “Project Propeller” has twirled away and the rest of the fanciful dreams and yearnings of the CEO can be summed up in the rather pathetic note that the Teradata implementation was so quick, “I believe we have been invited to speak at a conference on just this theme.”

Well, Patrick, you’re certainly not being invited to speak at a conference on how to run a great company.

Jeff Matthews
I Am Not Making This Up

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.

It’s the tale-end of earnings season, at least for companies on a calendar fiscal year, and for the most part earnings have been terrific—despite a very mixed reaction among the stocks themselves, especially in the technology sector.

For example, Apple, IBM, Amazon and eBay had nothing particularly spectacular to say—and yet their stocks took off based on little more than a relief that earnings had not disappointed and that guidance was, as Wall Street’s Finest like to say, “upbeat.”

Yahoo, Google and Microsoft, on the other had, reported no great tragedies—yet guidance was not judged “upbeat” enough, making the Street suddenly “downbeat” about their prospects and, therefore, sellers of those stocks.

So it is that these and other well-run companies have reported, and what is left are the stragglers—and one in particular that we monitor rather closely which will report tomorrow (following a one-week delay reportedly owing to unforeseen complications from a headquarters move and technology investments and an acquisition).

The company, of course, is Overstock.com, and in the spirit of this blog, which is to look at facts rather than engage in speculation, I thought it worthwhile to examine Wall Street’s earnings expectations for the company and provide my own preview.

For starters, Wall Street’s Finest are all predicting a fairly tight range of revenues right around $150 million, which their computers all seem to translate into a net loss in the equally tight 22c to 24c per share range.

One independent outlier expects far lower sales and somewhat lower earnings than the Street so we will ignore him for purposes of assessing “the consensus.” The most bullish “consensus” analyst, as I can see, is Craig Bibb, who assumed coverage at WR Hambrecht in April, a few months after the previous analyst, Bill Lennan, cut his earnings and revenue numbers and took his price target from $85 to $60, helping spark a decline in the stock.

Bibb took over for Lennan with a buy rating and a decidedly cheery note in which he compared Overstock.com CEO Patrick Byrne to Olympic Ski Champion Bode Miller. I am not making that up.

Bibb further ingratiated himself with Overstock by writing that “Management is taking a dynamic approach to finding the efficient frontier of growth and profitability…,” precisely the kind of Wall Street lingo that makes sense only if you start your day sniffing glue.

But back to our earnings preview: Wall Street expects Overstock.com to report a $4 million-plus operating loss in the second quarter of 2005—about a million worse than the $3.4 million operating loss reported in the first quarter of 2005.

This is based on a modest sequential decline in revenues, a pick-up in gross margins, and far higher selling, marketing, administrative and technology costs than in Q1.

To the naïve observer, this losing-money forecast makes no sense, because in his first quarter 2005 letter to investors Patrick Byrne identified $7.9 million worth of supposedly one-time items that reduced first quarter earnings, without which the company would have been handsomely profitable.

(Byrne had done the same thing in the fourth quarter of 2004, identifying $6.5 million of one-time items that supposedly hurt reported earnings.)

The items enumerated by Byrne this time included a $1.2 million shipping promotion; a $600,000 blown electronics deal; a $1.2 million bonus accrual; $1.8 million to market an auction and jewelry site; $500,000 on technology consultants; and a $2.6 million “binomial marketing experiment” which apparently, like Frankenstein’s Monster, went horribly wrong before it could be killed.

(For the record, even though nobody listening to that conference call had the faintest idea what constituted a “binomial marketing experiment,” Wall Street’s Finest dutifully wrote down “binomial marketing experiment” in their word processors and sprinkled the howler throughout their research reports later that afternoon and in subsequent documents, without ever actually explaining what a “binomial marketing experiment” might be.

I believe Patrick Byrne could have called it a “Supercalifragilisticexpialidocious marketing experiment,” and Wall Street’s Finest would have dutifully written “Supercalifragilisticexpialidocious marketing experiment” in their reports without a second thought.)

So, back to the first quarter numbers, and assuming Byrne was being accurate with those numbers on the conference call—keep in mind this is a man who tosses around numbers on conference calls like bond traders toss around $50 bills at Scores—Overstock would have reported $3.5 million worth of positive operating earnings in the first quarter.

And, therefore, without the $2.6 million Supercalifragilisticexpialidocious marketing experiment, the $1.2 million shipping promotion, the $1.2 million bonus accrual, the $600,000 blown electronics deal, the $500,000 on consultants and the $1.8 million on auction and jewelry sites that are stumbling out of the gate, Overstock should be able to make money in the second quarter—even assuming higher depreciation, higher rent and higher technology costs.

Unless, of course, Doctor Byrne was not being precisely, um, accurate with the $7.9 million worth of so-called one-time costs.

For help on this, I turned to Overstock’s “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (usually referred to as the MDA) in Overstock’s first quarter 10Q filing with the SEC, where companies normally enumerate those items which had significant impacts on earnings.

And in so doing I couldn’t find even one of the $7.9 million worth of items highlighted by Doctor Byrne.

For the record, the MDA is the place in a 10Q and 10K where companies are expected to discuss the guts of their business and report important factors behind changes in sales, margins and expenses.

Here’s what the SEC expects in the MDA:

The Commission has long recognized the need for a narrative explanation of the financial statements, because numerical presentations and brief accompanying footnotes alone may be insufficient for an investor to judge the quality of earnings and the likelihood that past performance is indicative of future performance. MD&A is intended to give the investor an opportunity to look at the company through the eyes of management by providing both a short and long-term analysis of the business of the company.

The discussion and analysis shall focus specifically on material events and uncertainties known to management that would cause reported financial information not to be necessarily indicative of future operating results or of future financial condition.

For the record, Amazon’s latest-quarter MDA runs for 28 pages, with great detail on all manner of sales and expense items.

Google’s first-quarter 2005 MDA runs 36 pages.

Overstock.com’s Q1 MDA runs for a little over 2 pages, offering a bare-bones description of the company and the components of its income statement, and that’s about it. Pull it off the web site yourself: you will find that in place of what normally constitutes the bulk of the MDA is something called an “Executive Commentary” which, for some reason, is excluded from the MDA with the following disclaimer:

This executive commentary is intended as a supplement to, but not a substitute for, the more detailed discussion of our business elsewhere herein.

Yet even here, only the $2.6 million marketing experiment was mentioned, and none of the other cost items Byrne had highlighted.

You’d expect a company that missed a quarter thanks mainly to $7.9 million worth of one-offs would explain this somewhere.

And so we await tomorrow’s report, which will no doubt include a wonderfully descriptive letter by the ever-erudite Doctor Byrne, explaining things to Wall Street’s Finest, and a conference call with Wall Street’s Finest asking acute and piercing questions of Doctor Byrne.

In the meantime, anybody with an informed opinion on the nature of those Supercalifragilisticexpialidocious “one-time” costs that seem to crop up time after time in the shareholder letters and conference call discussions is welcome to enlighten our readers here.

Tomorrow we will see whether Wall Street’s Finest—who expect a loss; or the naive reader of Overstock’s first quarter earnings report—who might expect a profit if for nothing else than the non-recurrence of $7.9 million worth of one-time items, is right.

Jeff Matthews
I Am Not Making This Up

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.

Whatever it is I’ve had the last couple of days, you don’t want to get. I won’t go into the details, but the result has been a lost weekend of sleep mixed with antibiotics, ear drops and codeine-laced cough syrup.

But why I even bring this up is my experience at the local walk-in medical clinic.

After a few days of feeling increasingly lousy, I dragged myself over there Friday morning, not thinking myself sick enough to bother my own doctor 30 miles away. I figured the walk-in clinic doctor would prescribe an antibiotic and some ear drops and be done with it.

Well, the walk-in clinic “doctor” listened to my chest—triggering a hacking cough; looked in my ears—triggering a painful ache in my right ear; asked me a few questions…and then told me to try an over-the-counter throat lozenge (I am not making this up) called Cold-eeze.

If you don’t recognize Cold-eeze—the brand name of zinc-based cold lozenges—you weren’t around back in 1999 when the maker, Quigley Corporation, settled FTC charges that the company made unsubstantiated claims about Cold-eeze’s ability to prevent colds.

But the controversy didn’t end there: a nasal spray version of Cold-eeze triggered lawsuits against Quigley for causing an intense burning sensation in the nostrils and damage to the sense of smell (“anosmia”)—and was discontinued by Quigley last year. (A friend of mine who used the spray actually experienced this, and it is not at all a minor thing).

So when I heard the walk-in clinic doctor say “Cold-eeze” and tell me that “according the literature” it works “although we don’t know why,” I almost fell off the examining table.

But I didn’t; nor did I say anything about the history of Cold-eeze and Quigley. I just got out of there as fast as possible and made an appointment with my real doctor.

When she walked into the examining room and heard me cough, she said, “that sounds bad” before she even picked up a stethoscope. And when she looked in my right ear—the one the walk-in clinic “doctor” had examined without comment, she said “wow—that’s really bad.”

Hence the antibiotics and codeine-laced cough syrup and ear drops, all of which appear to be precisely what I needed.

Next time I go straight to the real doctor.

Jeff Matthews
I Am Not Making This Up

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.

Consider the following tidbit that came in via a morning research compilation. I include it as sent, complete with misspellings and abbreviations.

Chinese 1Q urban employees salaries up 14.6% y/y, avg salary up 13.2% y/y

I do not know from whence the data came, nor do I know whether the 14.6% year-over-year increase in urban Chinese labor costs was “worse than expected” or “better than expected” or “in-line” with economist’s expectations.

But I do know that the “Chinese labor arbitrage” of which the bond bulls speak so approvingly continues apace…and while it is having a salutary effect on Wal-Mart’s cost of goods sold and Alan Greenspan’s CPI number, it is likewise having an inflationary effect on the Chinese labor market that would make a Peruvian Central Banker resign from his post, dig out the gold bullion from beneath his wine cellar and set sail for Bimini.

Only recently, fears of “a Chinese-led slowdown” caused Doomsday-Economist Steve Roach to jump to defect to the Bill Gross-led, Chinese-Labor-Arbitrage-Is-Deflationary side of the bond market food fight, about 50 basis points ago on the two-year treasury note (see “Even Armageddonists Need An Office” from June).

Yet today we read that the average Chinese urban salary—think about this for a minute—rose 14.6% in the first quarter.

I’m no math whiz, but I do know that 14.6% rounds up to 15%…and 15% a year doubles every five years.

In the words of Maxwell Smart, Agent 86 of CONTROL (why that show isn’t on cable TV somewhere in this great country of ours 24 hours a day is beyond me): “Would you believe, a Chinese-led reflation?”

Jeff Matthews
I Am Not Making This Up

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.

You’d think they could get the nachos right, at the very least.

I took our younger daughter out to dinner last night, just the two of us, for a little of the father/daughter time that I enjoy more than anything else in this world…but which probably causes her to think of the old Jack Nicholson line: “I’d rather stick needles in my eyes.”

But go we did, bypassing the local Chile’s where we went last summer for our bonding dinner because, as she reminded me, “it was pretty bad,” and heading for the Ruby Tuesday a few miles further down Route One.
I am moderately familiar with Ruby Tuesday, which goes by the ticker “RI” and has had a rough year or two after a spectacular turnaround. I went in with no expectations, positive or negative…just hungry.

I came out still hungry and looking for something to get the bad taste out of my mouth. The food could have been worse, I suppose. But not much worse.

The salad bar for which Ruby Tuesday is widely known contained leafy substances and sticky dressings in dishes on ice beneath those glass shields that are meant to keep germs out. Given the fact that I follow the health care industry pretty closely and understand that human beings shed skin like dogs shed fur, I am not a salad-bar kind of guy.

And, sure enough, I decided that by the look of it these particular glass shields actually kept the germs in. I decided the parking lot was more sanitary than the salad bar. So we did not order the salad bar, but we did ask for nachos.

The nachos contained more salt than I have eaten in the last seven years, and the so-called melted cheese did not appear to be cheese at all, but, rather, a cheese-like substance with the consistency of Ranch salad dressing, dripping over hot pepper-like spices that force immediate beverage consumption.

All of which quickly generates second rounds of soft drinks, of course, which is the point of all that salt and all those spices.

When the actual dinner food arrived, it was only modestly less disappointing than the nachos. My daughter’s chicken tenders were about as generic as they come. My own grilled chicken salad contained chicken that tasted about as firm and tasty as a rotten peach.

We didn’t stick around for dessert, which, I imagine, would have been some thawed out piece of heavy chocolate cake-like material, and coffee made out of whatever grounds they saved from the morning shift.

The wonder is that all these “casual dining” concepts—Ruby Tuesday and Chile’s et al, do as much business as they do.

I went to a P.F. Chang’s a year ago, and while the place was packed and the bar was doing land office business, the food was worse than our local Panda Pavilion. And the normal “morning after” reaction to all that MSG and oil and days-old cold-noodle-with-sesame, if you get my drift, occurred almost as soon as I paid the check.

Next summer, if Claire still wants to be seen in public with her old man, I’m taking her to The Cheesecake Factory.

Jeff Matthews
I Am Not Making This Up

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.

I’m not which headline is more interesting:

Oil Profits May Be Peaking

Or

Existing-Home Sales Rise 2.7%, Paced by Demand for Condos.

Both appear in today’s WSJ, and both are worth noting—the former because of its potential to be viewed as a wrong-way kind of complacency indicator; the latter because it reveals the seeds of the eventual real estate glut which are now being sown.

I’ll go with the condo story.

Here’s a piece of it:

Sales rose for all types of homes in all regions of the U.S., reports the WSJ, but the star performers were condos and cooperatives, where the sales pace has been running twice as fast as for single-family homes.

During the second quarter, condo sales were up about 37% on an annualized basis, compared with 22% for single-family homes.

The reason I find this especially interesting is 1) experience, and 2) what I’m hearing lately.

My experience with condominiums is that they are the eToys of the real estate business. You all remember eToys—the online toy merchant that came public in a burst of Amazon.com-initiated enthusiasm…and not too long afterwards hit the trees, as a friend of mine likes to say, with no flaps down.

Like all the other speculative, me-too dot-coms that were dreamed up, funded and brought public in the wake of Amazon’s spectacular success, eToys fulfilled a need: the need for investors who missed the early opportunity to invest with legitimate ground-breaking businesses to buy something—anything—that got them into the game.

And condos are like that, too: when housing gets tight, and real estate gets hot, investors look to condos to make some dough.

After all, they don’t require much effort, given that any condo in any development is pretty much the same as any other condo in that development. The school system, the distance to town, the neighborhood, the yard, the landscaping, the driveway, the roof, the gutters, the shingles, the wiring, the pipes, the basement—none of that stuff particularly matters.

After all, you’re not going to own it forever. You might live there a few years until you get enough vig for a real house; more likely you’re going to rent it to out and sell it a few years later to some greater fool.

Condos were the last part of the east coast real estate market to spike in the bull market of the mid-to-late 1980’s, and they seemed like such a no-brainer that my church bought a condo for an associate minister—the theory being that when the minister moved on, we owned an appreciating asset that could be used to fund great things.

But the condo did not appreciate. It did not even hold its value. And the equity got wiped out about as quickly as eToys stock. We were, it turned out, the greater fools…and when a church loses money, it hurts.

As for what I am hearing right now, let’s go back to that WSJ story:

Condo sales are strong nationwide and have reached frenzied levels in Miami, Las Vegas and San Diego.

And that’s interesting because of what I am hearing.

What I am hearing is that housing sales have hit a wall in Vegas, with certain developers offering cars to buyers of newly built McMansions. The reason? There are something like 100 condo projects in Las Vegas, and condo-mania is siphoning the speculative—er, “investment”—buyers out of the housing market.

Hence, a sudden glut of McMansions blooming in the desert.

Whether that glut is real or just a mirage on an otherwise tranquil horizon remains to be proven.

Informed observations are welcome.

Jeff Matthews
I Am Not Making This Up

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.

Oil service pioneer Schlumberger—for all the anti-French wisecracking that goes on these days (e.g. “France just raised its terror alert…from ‘Run’ to ‘Hide’”)—is one of the world-class acts of public companies, and has been almost since its founding back in 1912.

That’s right: in 1912—when armies still moved on horse-back—Conrad Schlumberger conceived of using electrical impulses to map rock formations below ground.

And this wasn’t some snooty France-only deal. Conrad and his brother began doing geophysical surveys in Romania, Serbia, Canada, the Union of South Africa, the then-Belgian Congo and the United States in 1923.

In fact, Schlumberger is probably the most international company I have ever come across in 25 years of doing this, and therefore one of the most interesting.

So a Schlumberger conference call is always worth a listen, if for nothing else than its ability to take you around-the-world-in-80-minutes.

But with the world in what feels like unusual flux, from Iraq to Russia to China to Venezuela and places in-between, the Schlumberger call takes on an especially value-added hue—and last week’s did not disappoint.

Rather than summarize the call in my “rambling and sarcastic” manner (thank you Business Week!), however, I am presenting here the most interesting, unvarnished dialogue from last week’s earnings call—with questions from Wall Street’s Finest and answers provided by ace Schlumberger Chairman and CEO Andrew Gould.

It needs no elaboration, although I have italicized the more potent comments.


Q: In the quarter here, you’ve posted over 40% incremental margins both looking at it year-over-year and sequentially for the oilfield. Given all that you see right now, do you believe that those kind of incremental margins are sustainable and for how long?

A: Let me put it this way, Geoff. I think that we still have considerable pricing power. I also think that we’re starting to see considerable inflation in the system and it’s a question of which one is going to go faster.

Q: Can you elaborate a little bit on the inflation comment and where you see that?

A: Not only in materials but even more importantly we’re seeing it in the cost of labor now.


Q: And are you taking any new actions in regards to labor in—where you’re getting labor from or anything else that—?

A: No, our problem is retention. Our problem is not getting it. Our problem is people poaching our labor.

So we have put certain retention mechanisms in place. We have had a general salary adjustment fairly recently, so you know, we have to get that back in pricing.

Q: I wonder….whether or not the slowing in oil demand growth in China is a concern to you or not?

A: The demand thing doesn’t worry me particularly, because you know, everyone is focusing on the IEA’s [International Energy Agency] demand remarks in the last week or two.

No one seems to have focused on the supplier, and what is really interesting is if you look at the supply numbers for the first half year, the non-OPEC supply is about 1.2 million barrels a day below what the IEA currently has in their forecasts.

So you know, I don’t think there is a significant elasticity being developed in supply demand for it to significantly affect the price.

Q: And a quick follow-up. Russian production growth has slowed dramatically.

A: Yes.

Q: Given that Schlumberger has more visibility into Russia than anybody, I was wondering if you could add some more color…?

A: We’ve always said that there are two factors playing. One is that we are moving towards the end of the period when it was easy to access the existing well stock that was drilled in the Soviet era, and to work that over and to produce more. Still possible—but a lot more difficult than it was three or four years ago.

And the second thing is…that people are reluctant to invest more.

Q: And Iraq? Any update…?

A: The last assessment was still that it was too dangerous for us to do anything.

Jeff Matthews
I Am Not Making This Up

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.

Well, they’re hiring in the valley.

Silicon Valley, that is. And it’s not just Google. Even Cisco, after a few years of keeping a tight leash on new hires, is out there competing for talent.

And it is getting competitive—“like 1998,” according to one friend with a history in the technology business, frustrated after losing a recent battle over a good new candidate.

Another friend—a mid-level engineer at a brand-name semiconductor company—is ready to bolt for an offer on the table if he’s not happy with his performance review this week. What would make him happy with his performance review this week? A big raise would make him happy.

I’m no economist, but that’s called wage inflation—something we weren’t supposed to get until the “labor arbitrage” with China was finished, which until yesterday’s move in the bond market apparently wasn’t going to happen for the next 10 to 30 years.

In fact, after yesterday’s revaluation in America’s Cost of Goods Sold—by which I mean the Chinese Yuan—our yield curve might start looking like the UK.

By which I mean inverted.

So whoever is buying those pools of “alluring and controversial mortgages that require unusually slim payments for a few years, before bigger sums fall due” from the likes of Ben Ray III (see “When 11 of 56 Leading Economists Agree, Something’s Wrong” below) might want to start checking those “low documentation” mortgages a little more carefully.

And make sure Billy Bob really does work down ‘t the Stuckey’s, like he tol’ Ben Ray III.

Jeff Matthews
I Am Not Making This Up

A Mortgage Salesman’s Pitch

If you read one article in one newspaper all day, make it that one, by the excellent George Anders.

It’s hard to miss, being on the front page of the Wall Street Journal—although with all the earnings reports and the Yahoo-head-scratching going on, you might easily pass it up, thinking to yourself, “ho-hum, another real estate bubble story.”

But this one is the real deal.

It details in startling, awe-inspiring detail the workload of one Ben Ray III, a Northern California mortgage lender whose bread-and-butter is supplying “alluring and controversial mortgages that require unusually slim payments for a few years, before bigger sums fall due.” And there is so much over-the-top stuff packed into this article it’ll make your head hurt.

It’s kind of like the dinner I had last night here in San Francisco with some old, special pals—everything was good.

And if you think the bottom of the available-pool-of-buyers has been scraped, wait til you get to the part about the latest twist in mortgage lending.

No, I’m not talking about adjustable-rate mortgages—everybody, including my dog Lucy, knows about all the ARMs being sold. And I’m not talking about interest-only mortgages—the commotion over which has probably reached my cat Marvin, it’s so overblown. I’m not even talking about the so-called “Freedom Loan” ol’ Ben pushes—called the “Prison Loan” by his competitors.

I’m talking about “low documentation” loans:

“…including ones where lenders simply take borrowers’ word about their income and don’t ask for pay stubs.”

Now, the reason this “low documentation” idea rings a bell with me is because of a story I heard a few weeks ago from the straight-laced guys at Northern Trust, which handles a lot of family trust accounts.

Business is off-the-charts good at “The Northern” thanks to the bank consolidations in which faceless behemoths try to generate “synergies” by replacing “human beings” with “call centers” and “1-800 Numbers” and “ATM Machines,” causing old-line families who want to talk to a “human being” about a minor issue like, say, their inheritance—and can’t get past the recorded message—to pack up their money and move it to a bank stocked with “human beings.”

And one of the stories they told was of a family with several hundred million in assets that had done business with a bank for over 200 years—and couldn’t get a $4 million loan from the bank. So the family took their several hundred million to The Northern where they could actually discuss things without pressing “1” on the touch-tone keypad.

Thus, it has come to this: a family with several hundred million in assets and a 200-year credit history has a hard time borrowing from their family bank—but thanks to folks like Ben Ray III, Billy Bob can now get hisself a house without even digging out his Stuckey’s pay stub from beneath the cushions of the couch he is paying through the nose for from the local Rent-A-Center.

No, I am not dumping on the Billy Bobs of the word. I do not think housing should be restricted to wealthy white families that bank at The Northern, and I particularly despise the inequities in lending costs between those wealthy white families that bank at The Northern and the Billy Bobs who get their pockets picked clean at the Rent-A-Center, a stock I would never own, placing it as I do on a par with tobacco companies.

But this is what it’s come to: low documentation lending. And there is much, much more in this excellent George Anders article. You really ought to read it start to finish.

The question this article raises, however—at least in my mind—is not how widespread these practices have become and whether low documentation loans signal The Top in the real estate mania. The question it raises is this: what is wrong with the real-estate-bubble-must-crash scenario?

I ask that question because of the following throwaway line in the story:

In a recent Wall Street Journal survey of 56 leading economists, 11 named a possible housing bust as their biggest worry for the economy.

We all know that anything widely anticipated—especially by 11 leading economists—will not happen the way those 11 leading economists expect.

Back in 1987, for example, it was generally accepted that stocks in Japan were highly overvalued—much like the dot-coms in 1999, and very much like real estate here today—and that if there was going to be a stock market crash it would start in Japan.

But the crash of 1987 did not start in Japan: it started in America, and it was triggered by a little-remembered device called “portfolio insurance.” I will deal with this device another day, but the gist of “portfolio insurance” was this: you sell when stocks are going down. Which is exactly what happened.

Thus, the Crash-That-Didn’t-Start-In-Japan came to mind when reading about Ben Ray III and the “low documentation” loans and all the other rotten loans that will surely come to grief.

And it causes me to wonder: what’s going to make those 11 leading economists wrong about the real estate bubble?

Jeff Matthews
I Am Not Making This Up

IBM delivered the goods with strong 2Q operating results…

Thus begins the Merrill Lynch message on last night’s second quarter earnings report from Big Blue, in which net income grew all of 5.4%

Revenue growth ex-PCs was 6%…

Actually, 2% of it came from currency, so the real revenue growth was 4%, but who am I to correct Merrill Lynch?

With operating EPS of $1.12 versus our $1.05 estimate…

For the record, this so-called “operating EPS” excludes a $1.7 billion restructuring charge related to elimination of 14,500 employees, which amounts to $1.06 per share. Is it really a heroic feat to “beat the number” by seven pennies, with one hundred and six brand new non-cash pennies floating around the balance sheet?

Of course, an IBM quarter isn’t really a quarter without a restructuring charge, so the appearance of $1.7 billion in charges was so unremarkable that Wall Street’s Finest barely remarked on it.

This is, after all, the same IBM which has taken $4.6 billion in “non-operating” charges in the last four years. So good is IBM at managing “non-operating” charges that, in one of the amazing accounting coincidences of all-time, this quarter’s $1.7 billion restructuring charge was almost exactly offset by $1.9 billion in non-recurring gains from the recent settlement with Microsoft and the sale of the PC business.

Who knows what future earnings potential lurks in $1.7 billion worth of “restructuring charge”?

But, getting on with the news that excited Wall Street the most:

Services bookings and profits sharply improved. Services bookings soared to $14.6 billion…

“Soared” is, in fact, an appropriate verb, since the services bookings were 45% higher than the year ago quarter. Unfortunately, bookings are still down 12% for the trailing twelve months.

Furthermore, the question arises as to how exactly did this company magically turn around a multi-billion dollar, people-intensive business in a mere 90 days? Accenture provided the answer when, on that company’s recent conference call, management spoke of IBM’s “aggressive behavior” in pricing new deals by saying “at any point in time” people act in such a way that “you scratch your head…”

And low and behold, the aggressive behavior may have consequences down the road:

[IBM] management also indicated that margins would be compressed in early years for some new contracts, as IBM is giving clients more savings upfront (i.e. lower pricing) with the intent of making up for this on the back end through better efficiencies down the road.

Nevertheless, despite the aggressive pricing,

… pretax margin rose with better consultant utilization.

When 14,500 people leave a company, the utilization of the remaining employees does tend to rise.

All in all, it was a typical IBM recovery from a weak quarter: mediocre sales growth, middle-of-the-S&P-pack net income growth and per-share earnings boosted by share buybacks, plus a big fat restructuring charge to help future earnings…and it was enough to bring a sigh of relief from Wall Street’s Finest.

IBM’s CEO said in the press release that IBM had “returned to form” this quarter after the first quarter’s poorly-received results.

With a $1.7 billion cookie jar—er, restructuring charge—safely tucked into the balance sheet; a rejuvenated backlog in the services sector purchased (according to even its most ardent fans) with up-front discounts not to be reckoned with for years to come; yet another lagging business (personal computers) abandoned to better competitors, and Wall Street’s Finest back on the sidelines, pom-poms waving, Big Blue is indeed “back in form.”

Jeff Matthews
I Am Not Making This Up

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.