A Bullish Case for Piper Jaffray (PJC)

The financial stocks in the U.S. and Europe have been decimated for fearing a Lehman like domino effect due to a potential Greek default, and because of the concern about a world-wide double dip recession. Some of the stocks are trading near their 2009 lows, just before Tim Geithner explicitly guaranteed the top "too-big-to-fail" financial institutions. One such stock is Piper Jaffray (PJC), which closed at $18.3 on Sept. 22. The stock bounced off its low since and has been trading close to $19.

Relative to its competitors, Piper Jaffray is much smaller and therefore much easier to manage. It also has a much simpler business. Its investment banking, institutional brokerage and asset management services, represented 50%, 32% and 13% of the total revenue in 2010 respectively. It does not engage proprietary trading, which can be very risky as shown in the recent case involving a rogue trader who booked a $2.3 billion loss at UBS. Furthermore, it does not have a prime brokerage business serving hedge funds. The prime brokerage business is a margin and commission business. However, it can be risky because the prime broker may have to take ownership of a troubled client hedge fund whose loss exceeds its capital due to excessive risk-taking.

If one were to use the ratio of total tangible assets to its tangible book to measure leverage, Piper uses roughly a third of the leverage in comparison with its competitors. As shown in the enclosed table, the Piper's ratio is about 4 and over 12 for JPMorgan (JPM), Goldman Sachs (GS), Jefferies (JEF), Morgan Stanley (MS), Bank of America (BAC) and Citibank (C) respectively. It survived the financial crisis of 2008 without taking TARP. As a matter of fact, they only had an operational loss of $75 million in 2008. They could have been profitable, had they significantly cut the compensation cost of $249 million. Another plus for the company, in this environment, is that they have very limited exposure in Europe both in terms of revenue (less than than 4% of the total) and the long-lived assets (less than 0.1%).

Key Risks

• First of all, this is not the industry for the long term share holders because of the excessive risk-taking and compensation. Furthermore, the commission or spread based institutional brokerage business has been experiencing industry-wide decline. Owners of the stock should consider exiting as soon as the financial crises subside and industry recovers. 
• Any financial institution that relies on short-term funding are at the mercy of the market perception of its credit worthiness. PJC currently relies on Repos (65%), commercial paper (23%) and short-term bank loans (12%) for its $513 million financing needs. I think this is not a significant risk given the friendly Fed under Bernanke.
• The company may have indirect exposures to risky financial institutions or sovereign debt through derivative contracts. 
• PJC is too small to qualify for too-big-to-fail insurance that the Fed and Treasury implicitly provides. In other words, PJC may be allowed to bust while its larger competitors will be bailed out in a crisis. 

Conclusion

At the current price of $19 a share, PJC is trading at a 35% discount to its tangible book value of $29.25 and PE ratio of 15.4 (using their EPS of $1.23 in 2010). Although, PJC is not the cheapest in terms of the discount to its tangible book or PE, but it is by far simplest and the least risky relative to the major shops on Wall Street. As we learned from the last financial crisis, what killed a financial institution was its leverage and amount of risky assets (New Century, Countrywide, Bear Stearns, Lehman Brothers, WaMu, etc.) in the last crisis. In summary, I believe PJC is the most attractive brokerage stock to own and can potentially offer a great deal of upside once the financial turmoil subsides and confidence returns.

Recap of Long Apple Calls Against RIM Calls

RIM missed earnings, guidance and gross margins in the latest quarter. The only positive that I could find was the higher expected phone shipment ("27% to 37%") in the coming quarter, and it was mostly due to their over-stuffing the channel in the previous quarters. The new BlackBerry 7 smartphones, which they touted so much in the conference call, are part of "the transition to QNX-based smartphones". That is real comforting for their long-term customers. All their future hopes are hanging on QNX-based smartphones, which are expected in 2012.

The main negative surprise for me was their paltry 200,000 PlayBook shipments, which were down 60% from previous quarter. Clearly, they were no match for iPads. The other downer was that they spent $780 million in acquiring part of the Nortel patent portfolio through a consortium, in which Apple is a part of. Since RIM needs to knock-down Apple and destroy the Android camp in order to compete, I just don't see the point of spending nearly a billion dollar to buy a bag of patents, which are useful for leaders to defend themselves against copycats. Does RIM have any copycats today? This is the trouble with troubled companies, which tend to throw good money after bad. HP (HPQ) just illustrated how they swallowed and choked on Palm.

RIM used to be a very successful and well-managed company. In many ways, it still is. I first encountered the stock at my old shop where my tech analyst was using a cool BlackBerry instead of a pager in the late 90s. They were the first major company to embrace message centric devices with full keyboards to counter then popular Palm OS-enabled devices using handwriting for input. RIM was able to dominate the personal digital assistants (PDAs) market, and later on the smartphone market. As a result, Palm was pushed to the brink of bankruptcy before HP swallowed it and now is trying to puke it out. I was a RIM customer and investor for years until Apple's introduction of iPhones in 2007 when I realized how great the iPhone was! The trouble at RIM has little to do with RIM itself, but everything to do with the iPhone. What Apple did to RIM is similar to what RIM did to Palm. This is just part of the tectonic shift, which happens from time to time in tech, and RIM just happened to be on the sinking side.

Position Recap

Since I recommended shorting 5 RIM Jan. 13 $40 strike calls vs. buying every 1 Apple Jan. 12 $400 strike call on Tuesday, Sept. 13, RIM shared tanked about 20% on the earnings' bust and Apple went up about 4% at the same time. Apple's (AAPL) calls are almost in the money now. RIM shares are 66% away from the $40 strike, quite safe from a takeover bid. As a result, RIM's call premiums got cut in half (from $4 to $2) and Apple's gained 18% from ($26 to $30.5). It was a good start and we should consider camping out for the new iPhone 5s.

at seekingAlpha.com:

http://seekingalpha.com/article/294308-the-trouble-with-rim-has-little-to-do-with-rim-itself

Long Apple Calls against RIMM Calls

Overview

The recent spike in volatility provides an excellent opportunity in shorting long-dated Research In Motion (RIMM) Jan. 2013 $40 strike calls ($4/contract at 44 implied volatility) against long Apple (AAPL) Jan. 2012 $400 strike calls ($26/contract at 32 implied volatility). I would recommend the trade at a ratio of 5 (RIMM calls) to 1 (AAPL calls). The central thesis of the position is to use options to express a bullish view on Apple and a bearish stance on RIMM. The expiration date for Apple is chosen to take advantage of the anticipated excitement of the introduction of iPhone 5 and the potential strong product momentum during the holiday season. Since RIMM has been a volatile stock along with the general volatile market, its option premiums have been highly inflated across all strikes and expiration dates. However, a short-term volatile stock does not necessarily mean a big long-term upside, which depends on the company's future prospect. If the trends for both companies were to continue (there is little evidence to the contrary), the upside for the position can be substantial with very little net premium upfront, which is preferable in the current uncertain and volatile environment.

Key Risks

1. A Turn-around at RIMM

At this point of the race to dominate the mobile devices, it is very hard for RIMM to catch up to Apple and Android. Their main competitor Apple is like the Mongol cavalry under Genghis Khan in the early 13th century. In order to compete effectively, RIMM needs a superior phone and a better tablet at the minimum. In addition, it needs to catch up in the race for apps as well. In other words, it really needs a miracle, and they don't have Steve Jobs as the great Khan.

2. A Disappointing iPhone 5

This is probably the biggest risk of all. However, I think this is highly unlikely given Apple's past track record and its perfectionist culture because Apple would rather delay a product than introducing a half baked device. A delay of the introduction of iPhone 5 until 2012 might be a bigger risk. 

3. A Potential Takeover of RIMM

My thesis of shorting RIMM has been based on its deteriorating competitive position against its competitors. It is always possible that some company may be interested in RIMM as a strategic asset or its patent portfolio as it was the case for Motorola. However, this is highly unlikely after Microsoft decided to push for its own Window phones with Nokia and the rest of the pack joined the Android camp. In addition, RIMM still commands a market cap of about $16 billion, a realistic takeover price tag has to be north of $20 to $25 billion, a hurdle very few companies can clear. To mitigate the potential takeover risk nonetheless, I picked the $40 strike, which is at a 33% premium to where the stock is currently trading. If the deal is in cash, the option premium would evaporate substantially. If the deal is in stock of a bigger acquirer, the call option should trade at a much lower premium, reflecting the lowered implied volatility of the acquirer.

4. Premium Decay

Because of the mismatch of the expiration dates of two calls, the decay on Apple call options is greater than those of RIMM. However, the decay is not significant until December.

Did Bernanke Give the Market a Needed Bailout ?

Overview

It appeared that Bernanke showed his magic once again after he hinted more "stimulus", which is really the "bailout" market participants have been looking for, at the next FOMC meeting in late September. The S&P 500 index rallied more than 4% in two days since the speech on Friday, or 7% since August 22 when the Jackson Hole event was highly anticipated. The VIX index (approximated by ETF VXX), which measures the short term implied volatility on the S&P 500 index (SPY) or is really a gauge of market protection insurance premium, declined roughly 10 points from low 40s to low 30s. More than a third of the rally occurred on 8/29/11, the day after the Bernanke speech. The rally was very impressive with all sectors such as tech, commodities, and more importantly banks participating. Bank of America (BAC) and Deutsche Bank (DB), which have been under severe pressure lately, shot up over 8% and 6% respectively. The advancing stocks overwhelmed the decliners by a ratio of greater than 10 to 1. Using a military analogy, the bears experienced a "Waterloo" type of defeat against the bulls! Historically, days like this usually mark the beginning of a new bull run. However, a good day does not a trend make. In the next a few days before the long weekend, the bulls need to hold off the bears in order to sustain their gained territory.

What is Next

Uncle Ben's challenge now is that he has to deliver the "goods" at the next meeting on Sept. 20th and 21st. A simple QE3, or printing more dollars, may not satisfy the bulls because QE2 did not do much other than causing commodity inflation around the world. Also, there are some indications that Obama is planning more stimulus in September.

In Summary, how these measures are perceived will determine if the bull run has legs or not.

Short Term and Long Term Challenges Remain

In the short term, the austerity measures are getting widely adopted in most of the developed world. Even China is cutting back to counter inflation. Without the expansionary policies and the subdued consumers, it is hard to achieve economic growth, without which the stock market will suffer (it already did). The sharp downturn in the stock market worldwide can cause the next recession. 

There is another structural issue in the long run. The success of capitalism globally has some side effects. One is the widening wealth gap between the rich and the poor. The rich lobbied policies in their favor and made the real reform difficult. As a result, the financial system/economy is still extremely risky. At the same time, the poorer poor make poor consumers, dampening the economic growth. In other words, the very success of capitalism undermines its own success.

Market Needs a Bailout

Overview

The initial debt concern in weak members of EU and the debt ceiling debate in the U.S. have now turned into a confidence and banking crisis in EU and the U.S.. The old market leaders in commodities and tech were slaughtered. There is no new leadership emerging. Most of the rallies were driven by the S&P futures and short covering.

Redemption Pressure by Institutional Players

It appears that the current market malaise is similar to the last downturn in 08, although we don't have a Lehman Brothers yet and the banking system is better capitalized in the U.S.. However, the process of selling begets selling among institutional players, especially hedge funds and mutual funds to satisfy redemption demands, is the same. The market is not trading on fundamentals in the short term, but rather on who owns what. Can the market recover on its own? Yes, market can rally, driven by bottom fishers, but only if the corrections are minor and no key financial institutions are at risk of defaulting. The bulls have been badly injured in the past couple of months. The fact that David Tepper who made a killing by buying bank stocks at the last crisis sold most of his Bank of America holding shows that the hardcore bulls are surrendering. Bill Miller, another religious bottom-fishing fundamentalist, has no money. Warren Buffett, the biggest and most patient of all, usually waits until other bulls are killed. Now, he is making a move by investing in Bank of America. In summary, it shows the bulls' lineup is dangerously thin. I believe we are closer to the situations of 1987, 1998, and fall of 2008 when the bulls are too weak to fight the bears. 

A Bailout is Needed

Capitalism is great, but it needs bailouts by socialists. Buffett cannot save the banking system by himself. If last crisis is any guide, the turning point, in my view, was the explicit guarantee of the major financial institutions by the Treasury in March 2009. All hopes right now hang on to Bernanke's Jackson Hole speech. After that, Obama will be next in line to save his presidency. A similar guarantee is needed in EU, but it will be a lot harder to achieve because Germans do not want to bailout non-Germans until the current crisis affects Germany more severely. I don't think we are there yet.

Stanley Druckenmiller

Street Stories: Managed Futures

 

Stanley Druckenmiller

Market Wizards Index: +37%
Compound annual over 12 years

Fund or affiliation

• Quantum Fund, Duquesne Fund

Methodology

• Holding a core group of stocks long and a core group of shorts, then use leverage to trade S&P futures, bonds and currencies.

Research Techniques Employed

• Focused his analysis on seeking to identify the factors that were strongly correlated to the stock price movement as opposed to looking at all the fundamentals.
• He also used technical analysis.

Trading Techniques Employed

• He never used valuation to time the markets. He use liquidity analysis and TA. Valuations only tells him how are a market can move if there is a catalyst.
• To attain truly superior l-t returns is to grind it out until you’re up 30-40%, and then if you have convictions, go for a 100% year. If you can put together a few near-100% years and avoid losing years, you can achieve really outstanding l-t returns.
• Soros taught: "when you have tremendous conviction on a trade, you have to go for the jugular. It takes courage to be a pig." As far as Soros is concerned, when you’re right on something, you can’t own enough.
• If a trade doesn’t work, Soros is confident enough about his ability to win on other trades that he can easily walk away from the position.

Philosophy and beliefs

• When you earn the right to be aggressive, you should be aggressive. A philosophy reinforced by Soros.
• The way to build long-term returns is through preservation of capital and home runs.

History and other facts

• At the age of 28 Druckenmiller launched Duquesne after a person offered him $10,000/mo. just to talk to him.
• In 1982, after losing all his money, he landed a client who had sold out his software business. This individual account allowed him to start using shorts and leverage.
• The queen in chess, which can move in all directions, is a far more powerful piece than the pawn, which can only move forward. [analogy: hedge funds vs. pension funds]

Examples

• Was dead wrong entering 19 Oct. 87 with a leveraged long position. Market opened over 200 points lower, liquidated his entire position and went net short; and made a small profit.
• Long Deutsche mark right after the fall of Berlin Wall in anticipation of expansionary fiscal policy and tight monetary policy.

Performance Record

• 37% over 12 years: "The longest-running measure of Druckenmiller’s performance in the markets is his own Duquesne fund. Since its inception in 1980, the fund has averaged 37% annually."

 http://www.streetstories.com/Stanley_Druckenmiller.htm

Antonio Gramsci

"History has left us an infinity of traces"
"The task is to compile an inventory of the traces that history has left us"
"To understand my history in terms of other people's history"
"to explain my experience through the experience of others"
"The goal is to include the other without suppressing the difference"

"Capitalism, it seemed, was even more entrenched than ever. Capitalism, Gramsci suggested, maintained control not just through violence and political and economic coercion, but also ideologically, through a hegemonic culture in which the values of thebourgeoisie became the 'common sense' values of all. Thus a consensus culture developed in which people in the working-class identified their own good with the good of the bourgeoisie, and helped to maintain the status quo rather than revolting.

The working class needed to develop a culture of its own, which would overthrow the notion that bourgeois values represented 'natural' or 'normal' values for society, and would attract the oppressed and intellectual classes to the cause of the proletariat. Lenin held that culture was 'ancillary' to political objectives but for Gramsci it was fundamental to the attainment of power that cultural hegemony be achieved first. In Gramsci's view, any class that wishes to dominate in modern conditions has to move beyond its own narrow ‘economic-corporate’ interests, to exert intellectual and moral leadership, and to make alliances and compromises with a variety of forces. Gramsci calls this union of social forces a ‘historic bloc’, taking a term from Georges Sorel. This bloc forms the basis of consent to a certain social order, which produces and re-produces the hegemony of the dominant class through a nexus of institutions, social relations and ideas. In this manner, Gramsci developed a theory that emphasized the importance of the superstructure in both maintaining and fracturing relations of the base.

Gramsci stated that, in the West, bourgeois cultural values were tied to religion, and therefore much of his analysis of hegemonic culture is aimed at religious norms and values. He was impressed by the influence Roman Catholicism had and the care the Church had taken to prevent an excessive gap developing between the religion of the learned and that of the less educated. Gramsci believed that it was Marxism's task to marry the purely intellectual critique of religion found in Renaissance humanism to the elements of the Reformation that had appealed to the masses. For Gramsci, Marxism could supersede religion only if it met people's spiritual needs, and to do so people would have to think of it as an expression of their own experience.

For Gramsci, hegemonic dominance ultimately relied on a "consented" coercion, and in a "crisis of authority" the "masks of consent" slip away, revealing the fist of force."