A Trader's Dream: Handicapping Indymac

Indymac stock (IMB), apparently left for dead at year's end, has risen from the ashes, dusting its peers in the sector (including buyout candidate Countrywide (CFC)) in the process. On January 31, there were 37.7 million shares still short (close to 50% of float, only 6 million off the highs of 43 million), and the exits (or entry) are getting crowded with short sellers covering, real buyers (doubling down), with speculators and traders going along for the ride. And what a ride it is likely to be.

After throwing in the kitchen sink in the fourth quarter earnings report, and reducing book value by almost 33% to about $16, INDYMAC appears to have put the worst behind it. Well, at least that is what the market thinks, with the stock nearly tripling off the lows (since mid-January to $11-plus) before pulling back to $8 a share last week. What's it worth? Well, by some estimates (including mine) $15 to $20 today (which is a modest premium to Q4 reported book value for a company with a decent chance of making a profit by Q2 in 2008). By the estimation of others, $4 or $5.

Who are the others, and why do they feel that way? They are the sell-side analysts toiling in the canyons near Wall Street and Broadway. They were, almost without exception, so late in downgrading the stock on the way down, that their credibility is at best, quite strained. In fact, one firm gets the grand prize for lowering its rating one week before the stock exploded to the upside. The unanimity in their bearishness is, in and of itself, the primary reason for why I am so bullish. Despite looming clouds of a continued broader bear market, I feel giddy at the prospects of another surge in the stock, and of the concomitant trading opportunities that lay ahead of us.

There are two thoughts to keep in mind over the next several months as the economy digs itself out of a housing recession. "If it's in the news, it's in the price." Don't talk about additional credit write downs. Mortgage and homebuilder stocks have never been cheaper this cycle. While the overall market may well make new lows this year, the lows are in for these two groups, in our humble opinion, for the financial sector as a whole. Pullbacks should be bought, and rallies should be sold.

The explanations sell-side analysts give for their bearishness suggests that they have completely slept through the last three weeks of trading activity in the market, and are oblivious to Federal Reserve's actions. Had they been early (or even on time) during the downswing in credit, perhaps one could take seriously some of the "losses" baked into the numbers. Perhaps investors should go back and look at their 2007 estimates from late 2006 or early 2007 (I did), and see for themselves.

There are three scenarios that many believed could be played out in 2008:

1) A distressed sale to big bank (as CFC apparently will, though hold on here comes Bill Miller).

2) Bankruptcy, as many smaller peers succumbed to.

3) The miracle rises from the ashes, and reemerges as a major originator.

The probability is now greater than 66% that the first two scenarios have been avoided, and the outcome points to number 3. That is not fully in the stock price, and until the stock reaches book value, and shorts buy back the 38 million shares, this name will be a money machine for nimble traders. If they couldn't take the stock down after the 4th quarter report, when will they???

Comments

[Whisper On The Wind]

IMB dumped the dividend last week.

[FIG trader]

I assume you didn't buy it banking on the dv'd. It's been well understood that they would a)lose money in Q4 07, Q1 and Q2 08 b) write down BV (in the four worst quarters) by something close to $10 a share; c) have to raise capital/eliminate dividend. Those are starting points in estimating takeout value, and, assuming independent survival, a starting point for growth in BV

[348s]

It would be helpful if you supported your opinions with some real-world analysis that showed how profitable IMB will be based on its new business model.