Testing

Fannie Mae better watch out, or it’s really gonna be in trouble.

As reported in today’s Wall Street Journal, Fannie’s regulator–the Office of Federal Housing Enterprise Oversight (OFHEO)–announced new requirements. And boy, are they tough.

For one thing, the new requirements would have Fannie Mae adopt policies “limiting employees’ ability to alter database records.”

Yes, that’s right. No more altering database records at Fannie Mae!

But it gets better: OFHEO also wants Fannie to adopt policies which “ban falsified signatures on accounting journal entries.”

Way to go, OFHEO! They finally get around to–after all these years–deciding that they don’t want the lynchpin of our national housing market to go around letting its people falsify accounting documents.

Man, when the Feds want to get tough, they really come down hard, don’t they?

Why Fannie Mae is still in business, with its Congressional charter and its overpaid executives and its fake accounting, is beyond me. But that’s my opinion. The rest of this piece, is, unfortunately, all too true.

Jeff Matthews
I’m Not Making This Up

CarMax Inc., the “big-box” used car retailer spun out of Circuit City years ago, carries a very fancy p/e ratio of nearly 30-times forward earnings despite the company’s inability to string together more than two up year-over-year quarters in a row since the fall of 2002.

The fancy p/e ratio probably owes itself to the fact that CarMax appears to be a great concept: the Best Buy (or Home Depot or Wal-Mart or whatever category killer you want to name) of the highly fragmented, poorly staffed, consumer-unfriendly used car business. Give people a huge, clean, well lighted store, with a transparent trade-in value and a pleasant buying experience, and the world will beat a path to your door.

At least, that’s the concept. And while the stores are in fact well run, and the buying experience very positive, CarMax has the least consistent earnings pattern of any actual category killing retailer out there.

The reasons CarMax has such a tough gig are several. For one, the company does not have a parts and service business, which is the flywheel in the hugely cyclical auto sector. For another, people don’t shop for a used car every couple of weeks, as they do for groceries or consumer electronics or hardware, so between the time they buy one CarMax vehicle and go back for another, they have to get re-sold on the CarMax value proposition.

And even if a satisfied CarMax customer does decide to buy another used car, they may have moved away in the two or three year gap. So the churn in the customer base is much higher than for the grocery shopper at the Wal-Mart Supercenter, or the building contractor at Home Depot, or the Play Station gamer at Best Buy.

Finally, CarMax’s sales depend on more variables–credit conditions, new car incentives, used car inventory–than any normal retailer. Thus, the company’s results vary both ways–to the good and the bad.

Right now, CarMax is varying to the good: last quarter’s unit comp store sales came in at the high-end of guidance and the company now expects the current quarter’s EPS to top its recently raised guidance by $0.01 a share.

There is–as always with CarMax–a caveat. The caveat to the sales acceleration is that it coincides almost precisely with the company’s rollout of sub-prime financing (called “DRIVE”) to its stores in August of 2004.

Indeed, sub-prime contributed 5% to the recent 12% comps.

Most analysts expect the sales impact from DRIVE to diminish over time. It is hard to imagine how it will not. Meanwhile, the earnings benefit is quite a bit smaller than it might otherwise be, because CarMax has over 100 million shares outstanding–and in a low-margin business like used cars, there’s not much left over for shareholders no matter how big the sales boost.

Analysts seem to love this one, for reasons that escape me, except that some very smart investors own the stock and have played it quite well over the years. That plus management’s open playbook and excellent systems make this an easy name to go back to when the stars are lining up for a couple of good quarters.

But the fact that CarMax is juicing up sales by reaching down the credit curve illustrates the problem here: there is no fundamental franchise in used cars.

Let the buyer beware.

Jeff Matthews
I’m Not Making This Up

According to the crack analyst team at Midwest Research, the current 3-plus year rally in the Commodities Research Bureau Index recently became the longest on records going back to 1960, by 15 trading days.

Perhaps this fact is one reason Alan Greenspan calls the current long-bond yield “a conundrum.”

On the other hand, the bond market–especially after Friday’s ‘whoopee’ reaction to the jobs report–would probably take the glass-is-half-full view, and point to the fact that the CRB is at the peak of an extended run as a clear indication that the China-driven raw materials inflation has peaked.

Whatever the case, on top of the long-running surge in oil prices–one of the reasons behind the CRB’s hefty move of late–oil-rich Iran has just warned that any attempt to impose sanctions on its nuclear activities would lead to an oil crisis in the US and Europe. “Playing with fire” is what Iran’s top nuclear official called it.

Not for nothing that the last oil shortage–in 1979–was caused by production cuts in…Iran.

Perhaps the bond market is right, and Alan Greespan is wrong. Perhaps, though, as the CRB suggests, the bond market is playing with fire.

Jeff Matthews
I’m Not Making This Up

Hovnanian reported today, and the numbers were all–this is a homebuilder, you see–excellent.

Except for one small piece of the business, which happens to be Hovnanian’s captive finance business.

“Due to the falloff in the re-finance business, Hovnanian is experiencing competition from third-party mortgage lenders who have been reducing their margins in order to originate more new business.”

Seems also that there’s an increasing demand for adjustable rate mortgages, which are less profitable than the old-fashioned fixed-rate kind–and this too hurt the finance arm.

ARM’s were–get this–45% of origination volume in the quarter. That’s right: almost half of all Hovnanian’s mortgage volume is of the let’s-take-the-lowest-monthly-payment-mortgage-because-otherwise-I-can’t-afford-this-house variety.

But not to worry: “According to the Brookings Institute,” the company reported on their conference call, “new housing starts should average 2 million a year for the next 25 years.”

Phew! Thank goodness. If somebody at the Brookings Institute says so, it’s gotta be true!

Seems to me the Housing Bubble is here. But not to stay.

Jeff Matthews
I’m Not Making This Up

According to the National Association of Realtors, who should know, second homes accounted for 36% of U.S. home purchases last year, up from more than 16% in 2003. That 36% breaks down thusly: 25% of homes were bought for investment; 13% bought as vacation homes.

Think about that for a second. More than a third of all homes bought last year were bought for either speculative purposes or as vacation homes.

This doesn’t square at all with the mantra of the home building companies and their fans, which is that the U.S. has a perennial housing shortage caused by job creation, immigration and the deep-seated hunger for home ownership.

It has nothing to do, they assure investors, with the recent 4% 10 year treasury yield. It has nothing to do with adjustable rate mortgages or “IO” loans–interest only loans–in which the only thing the homeowner pays is the interest, leaving the principle for later (which to the buyer means “when I flip the thing for a big profit”).

And it has absolutely nothing to do with speculative buying, according to home builders including–and I’ve heard them all say it–Toll Brothers, Pulte, Lennar, KB and Hovnanian.

But now we know the facts: home purchases were inflated a full 20% (the jump from 16% in 2003 to 36% in 2004) by boomers snapping up spec housing and vacation homes around the country. That’s a bubble.

And not for nothing, it seems the average single-family home financed by Fannie Mae or Freddie Mac shot up almost 12% last year, the highest rate since 1979. For those who remember that far back, 1979 ushered in a couple of pretty ugly years in the housing market.

Jeff Matthews
I’m Not Making This Up

I have a friend who enjoys shaking up dinner conversations and cocktail parties by saying something inflammatory–“So I’m thinking of buying a gun,” he’ll say; “What do you think?”–then he sits back and watches the fireworks.

Thus it has been with this blog: a discussion about Overstock.com CEO Patrick Byrne’s obsession with short-sellers, his relation to an oddball Conspiracy Theorist calling himself Bob O’Brien, and the vacuity of “X-Files” O’Brien’s conspiracy case has given way to an intense shouting match leading to precisely no conclusion.

Although it does lead somewhere very interesting.

We know, for example, that “X-Files” and his cohorts have taken the threads of established cases of illegal naked shorting in stocks that hardly merit serious discussion, and woven a broad Conspiracy encompassing professional short-sellers in general and shorts in Overstock.com, in particular.

Unfortunately, for his case, “X-Files” ignores the fact that professional short sellers view naked shorting the same way he does: illegal. But pros go further: it is not only illegal, it is amateurish and also stupid. Hence, whatever Overstock.com’s problems are, they come not from naked shortsellers..“X-Files” not only refuses to believe this, he goes off the deep end by making very bizarre claims, including one that the hedge fund industry has been “linked to organized crime” and another that hedge funds such as those involved in Overstock.com violate the Patriot Act by accepting funds from terrorist groups.
These are serious charges and might be seriously considered, except that Mr. O’Brien practically declares himself certifiable by stating, and I quote:

I have contacted the FBI. My attorneys feel that given the players involved, only a madman would reveal his identity and strap a bulls-eye on his chest at this juncture. I thought they were being paranoid two years ago, but now I believe they are just being prudent.

What we’re dealing with here, I think, is a crackpot. A certifiable crackpot.

Now, that’s my opinion. Others might say he is merely eccentric, or a whack-job, or a harmless nut. The correct adjective is not important, what is important is this: why would the CEO of a large, widely owned, publicly traded company give over a significant portion of his earnings call to an individual who is so misguided as to the facts, and, apparently, a certifiable crackpot?

That’s a question that merits a serious answer, because real public companies–and I had included Overstock in that category until “X-Files” more fully revealed himself here–do not allow their earnings calls to be hijacked by crackpots.

Note: This blog is not an Overstock.com blog, nor is it a Patrick Byrne blog, nor an “X-Files” O’Brien blog. I will be moving on to other topics. But I’m still looking for answers to the fundamental questions already raised about operating issues from Overstock’s last quarter. Anyone who knows–and who is not making it up–is welcome to respond. Certifiables are not.

One of the best pieces of advice Warren Buffett gives about the market is, when investing in a stock, know everything you possibly can about it so you have the advantage over everybody else playing in that stock–otherwise don’t invest. He says: “if you can’t figure out after a couple of hands who’s the patsy at the poker table, then you’re the patsy.”

I think we know who the patsies are in Overstock.com.

Reading the responses to “When CEOs Obsess” from the individuals for whom Overstock.com CEO Patrick Byrne is a hero and the imagined short-selling cabal a dastardly, criminal conspiracy has been enlightening in the same manner that hearing sleep-deprived, sports-obsessed shut-ins call up Mike & The Mad Dog on WFAN to rant about whatever team of theirs recently lost a game: it helps one understand why Yankee manager Joe Torre pays no attention to the drunken sods in the bleacher section yelling pointers in between throwing up on their friends; and it makes one wonder why on earth Overstock CEO Patrick Byrne allowed an ill-informed misfit, Bob “X-Files” O’Brien, to hijack Bryne’s last earnings call for the sake of an error-laden rant against imaginary foes.

Both constituencies–whining, ignorant sports fans and whining, ignorant Short-Seller-Conspiracy Theorists–are grossly ill-informed about the way things work in the real world, but I think the Patrick Byrne acolytes are more delusional, in that they have spun a richly imaginary fantasy to explain movements in a particular stock which have hardly, to use Patrick Byrne’s words, forced grandmothers to “be eating dog food so a couple hundred guys on Wall Street can be driving Mercedeses”–unless the grandmothers were short Overstock.com on its way from $10 bucks a share to $70, and the Wall Street guys were long. Sports fans, on the other hand, always blame the coach.

Let’s review the basic, fundamental case of the Bryne Acolytes: despite the fact that far more money has been made in Overstock.com stock from the long side in the last two years than from the short side in the last two months, “X-Files” O’Brien has stated that Overstock.com’s problems are the result of millions of shares of stock routinely traded which supposedly far exceed the 6.9 million shares float–never mind that hot NASDAQ stocks such as Sirius routinely draw day traders who inflate the average daily volume.

These millions of mysterious excess shares are supposedly caused by “naked” short sales from the evil Short Selling Cabal, which in effect creates “counterfeit” stock, according to “Peanut”…er, “Pistachio.”

And somehow–even though Overstock’s share price has increased from $10 to a recent $55–this “counterfeit” stock is driving down the price of Overstock.com. Or at least keeping the stock from reaching its true value.

One would think if Overstock.com is indeed trading millions of shares beyond its actual available shares, and if a “massive” short-selling conspiracy does exist, then the failure to deliver would amount to–I’m only stating what the conspiracy theorists have reflected in their posts–millions of shares.

According to “Peanut,” however, the amount of Overstock. com shares failing to deliver amount to less than 100,000. This is hardly “millions.” Nor is it enough to influence Overstock’s share price, given that almost 30 million shares traded in January alone.

I think I’ve figured out who the patsies are here: X-Files O’Brien heads the list, followed closely by Peanut and their fellow poster named Jake, for they have hitched their stars to a CEO who appears paranoid about a threat from a Short-Seller’s Cabal which does not exist.

Oh, sure, there are short-sellers out there who think Bryne is full of it, and that Overstock.com will go the way of other overly-hyped, low-margin internet models. That’s their opinion and they’re entitled to it–surely as the legitimate long-term investors in Overstock.com have their own, differing opinion and are entitled to it.

And the shorts have shorted Bryne’s stock, and they even talk to one another about what they’ve heard out in the field and what they learned on the conference calls, and they even discuss with reporters–there’s a thing called “free speech,” is there not?–how bizarre it is that this CEO spends so much time engrossed in a vain effort to stamp out the skeptics surrounding his company when, in reality, running his company well, delivering good numbers, and creating true economic value, are the truly the best revenge.

And guess what: there are even shorts who sell naked even though it’s illegal. And they are stupid amateurs who deserve to be caught and get whatever’s coming to them.

But the “conspiracy” among professional shortsellers does not exist. And by creating the spector of one, in order to explain losses in their own portfolios in a stock that has risen from $10 to $55, X-Files and his crew reveal themselves to be the patsies at this table.

As for me, I wouldn’t trust Patrick Byrne to run a successful company over the long haul. He’s too obsessed with the shorts, and his conference calls always raise interesting issues that the analysts covering the stock don’t get into.

For exmple, “Its strange” raised a good point in response to “When CEO’s Obsess” when he asked how Overstock got “the steal of a lifetime” in a $7 million diamond purchase against all the other, larger competitors out there. (I wonder if it’s going to be as successful as Patrick’s big watch buy a year or two ago.)

If anybody out there has the answer to “Its strange”–and I mean anybody real, not X-Filian Conspiracy Theorists or Amateur Naked Short-Sellers–then I’d like to hear about it.

Furthermore, I’d love to know what vendor received stock options to sell product to Overstock, resulting in a “vendor comp charge” of almost $1 million last quarter.

Also, Byrne claimed on the call that “we just marked down, promoted, did whatever we had to do to blow out the older inventory.” He said Overstock lost $1.5 million on that inventory. I’d like to know what the old inventory was, what his actual cost was, and how he went about blowing it out.

If the patsies here–that is, the Conspiracy Theorists–really know their stuff, they’ll have the correct answers. If they don’t know their stuff, they’ll just go back to their Conspiracy Theory.

I strongly suspect we will not be hearing anything from them in the factual realm.

P.S. For a good example of how not to behave like Patrick Byrne, read Google’s S-1, earnings and analyst presentations carefully. You will not see or hear the word “short-seller” in any of their material or any of their calls, despite a substantial short position in Google shares. That is because the Google guys are hell-bent on doing what they do well, and letting success in the business take care of the stock, which will, over time, take care of the shorts.

Overstock.com is no Google.

Overstock.com is a high-flying company whose CEO, Patrick Byrne, has a problem with success. His problem, specifically, is that the success of his company has attracted short-sellers of Overstock.com’s stock.

While I do short stocks occasionally as part of my investment strategy, I am not one of the short-sellers Mr. Byrne–actually, Doctor Byrne–goes after on his earnings calls and in his erudite shareholder letters. The shorts he goes after are so-called “naked” shorts, meaning they have not actually borrowed the shares of Overstock which they have sold short.

Not only is naked selling short illegal, it is, from my vantage point: a) stupid; and b) not the way any professional short sellers I know go about their business.

So I think Doctor Byrne is identifying a problem that doesn’t exist. And if it does exist in the case of Overstock.com, then those so-called naked shorts, whoever they are, will eventually have to buy back the shares of Overstock they have shorted–a good thing for the Doctor and other shareholders of Overstock, should they ever need an exit strategy. He should be thanking the idiots doing the illegal deed–not obsessing about them.

Why write about Overstock without having a dog in this fight? Simple: I have found in my 25 years’ investment experience a very high correlation between companies whose CEOs obsess about short-sellers and the eventual self-destruction of those companies.

CEOs who obsess about a non-operating issue such as short-sellers usually have a very fragile business model–otherwise, they would not waste a second of their time on such useless speculation. Or they simply have something to hide–sometimes fraud, sometimes not. In general, what comes to mind when CEOs obsess about shorts are the words of Queen Gertrude–from Shakespeare, with whose work I’m sure Doc Byrne is very familiar: “The lady doth protest too much, methinks.”

And Patrick Bryne protests way too much.

Bill Gates, as one example of a CEO whose stock has, in the past, been heavily shorted, never bothered to get worked up about any short-seller on any Microsoft conference call, ever: he just ran the business and let the stock take care of itself, and take care of the shorts along the way. In fact, when I am short a stock, I get very nervous if the CEO does not obsess about the shorts. It usually means he’s playing a very strong hand.

But don’t try to tell this to Patrick Byrne, because today he’s whining to Floyd Norris in the New York Times that “someone is manipulating our stock,” and blaming the shorts for the recent 15-point drop following an earnings call that disappointed investors expecting positive surprises. (Bryne does not, by the same token, thank the shorts for facilitating the 60-point rise in the prior twelve months, nor does he grasp the fact that he and he alone is to blame for raising ridiculous expectations and then failing to meet those expectations during the company’s earnings call.)

Speaking of that call, you should listen to it. The whole replay. Especially the last twenty minutes, when Doctor Byrne fields a call from a man identifying himself as Bob O’Brien. “The name is not familiar,” O’Brien says to Byrne, “let me start out by introducing myself.”

The “not familiar” Bob O’Brien then delivers a paranoid and wholly ignorant fantasy regarding the supposed short-selling conspiracy driving Overstock and other small cap companies into the ground, including factual errors regarding the mechanics of stock delivery and ramblings of an individual with far too much time on his hands and who probably has a difficulty distinguishing reality from The X-files.

You will hear Doctor Byrne patiently let the man ramble, expressing surpise and interest in the caller’s fantasy, and you will hear Doctor Byrne act wholly ignorant of where this Mr. O’Brien came from. “I don’t know any of the stuff you are talking about but it is interesting stuff,” Bryne says.

Patently false.

Turns out Patrick Byrne helped an organization called “National Coalition Against Naked Short Selling” pay for two Washington Post ads attacking naked short sale tactics. Turns out this so-called coalition is run by none other than the paranoid X-Filian Bob O’Brien.

But don’t take my word for it. It’s all there in the interviews Byrne and O’Brien give to Floyd Norris in today’s New York Times. Read the article and listen to the Overstock conference call, and tell me what you think.

If a CEO will fib to Wall Street the way Patrick Byrne appears to be fibbing on his earnings call by hosting an orchestrated short-bashing rant from his “not familiar” friend Bob O’Brien, you never know what he might do when it comes to running a business.

I am not making this up.

You know a fad is getting out of hand when everybody tries to replicate it. And you know this iPod thing is really getting out of hand when a food company tries to compare itself to Apple.

This really happened.

Irwin Simon, the hard-selling CEO of Hain Celestial Group, which owns a slew of natural foods brands ranging from Walnut Acre salsa to Celestial Seasoning teas, recently told Wall Street on a conference call: “We really have–which I call the next iPod of products coming out.” (I’m not making this up.) “That’s been my challenge…what’s the next iPod for Hain?”

Funny thing is, Hain is finally unwinding the remnants of the ‘carb’ craze products they introduced last year, right as that fad was peaking. So for Apple’s sake, let’s hope Hain doesn’t introduce a music player any time soon.

Highfields Capital Management, a very good hedge fund out of Boston–one of the first to recognize the behind-the-scenes fraud at Enron–has bid $17 a share for Circuit City, the beleaguered electronics retailer whose current advertising theme is the old Cars song, “Just What I Needed.”

Wall Street applauded and bid up Circuit City stock on the apparent belief that Circuit City has the kind of hidden real estate value which has made other hedge funds go after Sears, K-Mart and Toys R Us. Unfortunately, Circuit doesn’t have much of what anybody needs, including customers.

Circuit leases its stores, sold off its credit card business a few years ago, and has nothing much more “hidden” than profits, which elude its grasp like thiefs eluded Barney Fife. And Highlands probably knows this.

So I imagine Highlands–very good at running a hedge fund; probably not so good at running a retail chain–is trying to smoke out another bidder to get Circuit’s stock off its books and move on to the next idea.

The way I imagine the conversation between Circuit City’s Board of Directors and the Highlands people, it goes like this:

Highlands: “We are prepared to make an all-cash tender offer–“

Circuit City Board: “How much?”

Highlands: “As I was saying, we are prepared to make–“

Board: “How much?”

Highlands: “Well, we are prepared to offer seven–“

Board: “DONE.”

Highlands: “Don’t you want to hear the full price?”

Board: “Uh, sure.”

Highlands: “As we were saying, seventeen dollars–“

Board: “A share???”

Highlands: “Er, yes, seventeen–“

Board: “DONE!”

##

Now, I don’t own any Circuit City stock, although I did look at it when it was trading below ten bucks a share, but I could not get around the fact that the Internet even then had begun disintermediating the business of selling commodity electronics products, and Circuit City and its ilk were becoming the functional equivalent of dinosaurs. So I left 70% on the table and I regret not doing the trade, but the disintermediation has intensified, if anything, since then.

I bought a notebook computer last fall at Best Buy, which I figured would be relatively painless but was in fact a horrible, we’ll-be-right-with-you/excuse-me-while-I-take-care-of-this-other-customer/would-you-like-a-service-contract-with-that experience. So, a month later I bought an iPod for my daughter, using the Apple web site: it was shipped 2 days later via Fedex. Easiest buying experience ever.

Consequently, I wouldn’t own Circuit City at seventeen bucks a share, or sixteen or even fifteen. Memo to Circuit Board: this Highlands bid may be just what you needed. Take the money and run.