The Short Case on HSBC Holdings

HSBC Holdings, PLC (HBC) is a United Kingdom-based banking and financial services organization. Its international network comprises over 10,000 branches in 82 countries and territories. The headquarters is in London. HSBC provides a full range of financial services to more than 125 million customers. HSBC has recently been on a buying spree, acquiring banks in South Africa, Argentina, and Australia. In 2003, HSBC also bought Household Finance, which was a market leader in credit card and home equity loans in the U.S. Subsequent to that acquisition, HSBC has had to close the mortgage origination division of Household, and take several multi-billion dollar charges against earnings for the losses stemming from that acquisition. .

As we have all been reading, foreclosures and delinquencies have surged in recent months, particularly among homeowners who took out high-risk mortgages. The distress has forced several mortgage lenders into bankruptcy and stoked anxiety that the problems could spill over into the broader economy. If these impairments to value continue – Citibank (NYSE: C) and Merrill Lynch (NYSE: MER) have each taken multi-billion dollar charges for their mortgage backed bonds and SIVs - and we see the potential for a significant negative impact to HBC’s earnings and/ or equity value here.

HBC is also heavily exposed to credit card assets. In that light it is similar to Capital One (NYSE: COF) which yesterday slashed its earnings estimates by over 20%. We see potential for a negative impact to earnings from this exposure as well. In this situation and in this credit climate, the risks are not necessarily outweighing the rewards. We still feel a short position presents a compelling opportunity.

Chart Discussion

HBC’s current chart shows a meaningful rise in the stock price in the September – October 2007 timeframe, which was concurrent with the Chinese market’s latest run and the Fed’s interest rate cuts.

Since then, the stock has been hacked pretty severely – by over 20% - and the moving average indicators and relative strength lines are also horribly weak. With daily moves of several dollars appearing in December 2007, there are numerous gaps in the chart.

We think the high for the shares was back at the $98/$99 range 3 months ago, and the risk / reward for a short position is still quite favorable.

We believe the likely top in this stock for the next few months or so was in October 2007. We also believe shares could trade down another 15% to 20% or so, to a level below the $68 - $69 price point within the next three months as continued fallout from the credit market (the SIV’s, subprime mortgages and credit card defaults specifically) impacts the industry, and HBC specifically.

Recommendation

We would recommend investors consider buying the HBC March 2008 $75 strike price puts, which are currently at $2.05 bid / $2.15 ask. We would seek to exit those puts when the stock reaches a price point of $69 or lower, or when the puts are trading at $6 apiece or more.

Put spread buyers may want to buy the aforementioned March 2008 $75 puts, and sell the March 2008 $70 strike price puts for $0.90 (current bid). This would limit the risk an option spread buyer would have to approximately $1.25 ($2.15 for the long March $75 option, less the $0.90 for the short March $70 option), and also limit the potential upside to a maximum profit of $3.75 ($5.00 spread differential, less net cost of the spread).

Disclosure: Analyst has no HBC positions.

Comments

[kkin365]

Good discussion. Your put recommendation is well thought out. Well done.

[Daniel Jones]

Glad you liked it - overnight action in Hong Kong and today's action in the name makes those puts very nicely valuable. I am really scared for the entire market right here. Could be playing out one of two ways: 1) the market gets an interim rate cut, heaves up 250 points as short covering burns everyone to the upside, but then there is a calamitous economic report or an overnight foreign bank collapses and we have a 600 point down day soon, touching sub 12,000 eventually, or; 2) the market has a series of wrenching down days, touching below 12,000 before the market interim cut is delivered. It languishes there for about a month to 6 weeks before starting to recover. Volatility reigns.

[Daniel Jones]

Wow - volatility indeed does reign. Be careful out there everyone.