The Emperor (Mr. Ackman) Has No Clothes

It seems that the market has uncovered some rather large holes in Mr. Ackman's recent pronouncement that the financial guarantors and their policyholders are screwed.

It amazes me how simple some of these concepts were and makes me wonder how such and astute money manager could miss these concepts in his analysis.

1. Insurance vs. Investment Bank. Guarantors write insurance and as such there are significant protections written into their contracts (holding the unwind rights on CDOs they insure is pretty valuable). Also, they are not responsible for the entire insurance obligation listed in their financials due to subordination and other contratual protections written into insurance contracts. Look through Assured Guaranty's (AGO) supplemental disclosures to get more comfortable with the value of this aspect of their businesses.
2. Present Value.  A $1 billion CDO liability that is not due until 30 to 40 years from now is only $181mm in PV terms at a 5% discount rate.
3. Buying CDS on Insurance Opcos. Mr. Ackman's vision for the industry was that they would all be put into receivership. Mr. Ackman bought FSA CDS to reflect this view. The Maryland Insurance Commission has just worked out a settlement to keep ACA out of recievership and bankruptcy. For ACA to be restructured without recievership essentially makes the CDS contracts (at the insurance opco level) worthless. It is my understanding that the provisions in insurance related CDS contracts do not include a restructuring clause. Thus there is no payment to buyers of ACA CDS on this settlement. This also points to the fact that the regulators will not (unlike the ratings agencies - their recent move on AGO is a joke) bow to market pressure and remain strongly supportive of the industry.

Both Ambac (ABK) and MBIA (MBI) disclosed adjusted book values in their Q2 results; if I adjust these disclosures, I get the following: Ambac's $3.6 billion MtM losses (which I expect to reverse) gets added back for a book value per share of $30.04. MBIA's expected addtional $2.5 billion of reserve build gets subtracted out for a book value per share of $29.13. In my opinion, Ambac has been far more conservative in its reserves. They reserve to their more conservative internal ratings, where MBIA reserves to the lower of S&P and Moody's. Most of the firms in this sector offer amazing buying opportunities for the long-term investor.

More important is that these adjusted book values will not change all that much going forward. Why? Because most of the downside to adjusted book value per share has been modelled in at current reserve levels. Because correlations for senior tranche structured debt instruments remain and unsustainable levels. Lastly, becase the recent mortgage bill will have a huge affect on senior tranche RMBS related products due to higher recovery rates for RMBS assets.

I have not seen many 700% return opportunties paired together with minimal liquidity risk. The really crazy thing is the fact that this does not even include the fact that their business could pick up in the future.

Even if wrapping muni securities goes away (which it won't because the economics still work), some of these firms could get involved with writing mortgage insurance.

Remember some of the simple things that Mr. Ackman left out of the analysis next time you see him on CNBC.

Disclosure: Author holds a long position in ABK

Comments

[Ishortyou:]

AMBAC and MBIA are cracking open CDO-ABS-MBS-SIVs containing fraudulent loans. AMBAC is cracking open 84,000 of them, many rated triple A but the examination is revealing that those 'triple A' ones contain JUNK so it will take some time to remediate their books. The other suggested strategy is to sell their CDS and policy contracts on these triple A rated-JUNK to bottom feeders for an 'attractive price' with this they will achieve a good capital/liabilities ratio to regain their triple A status and write new public high quality business again.

2008 Aug 11 06:03 AM

[glassbox:]

Don't forget bond insurance for public infrastructure related projects and international markets demand for such products. The guys at ABK and MBIA have been in the business long enough - this is the time we can hopefully sieve the wheat from the chaf. Long ABK for at least a 12 month ride - believe it will eventually go back above their internal adjusted BV of at least US$17. Well, if it doesn't, at least is a US$4+ perpetual option bet.

2008 Aug 11 06:59 AM

[fxtrader07:]

Well, are you really so naive to think that Ackman ever believed the stuff he was telling the public day after day? All he needed to get done was to create enough fear and panick. Not to be right with his claims. I would certainly not be surprised to learn that he actually was now long the monoliners.
That being said, the picture is not as rosy for ABK and MBi as you might think. They will be able to deal with their mistakes in the CDO business, sure. But their main business was insuring muni-bonds and if you look at the precarious state of the us economy and the quick deterioration of federal and municipal budgets (collapsing tax revenues!) this spells lots of trouble. I am cautiously long mbi/ABk, mostly senior debt, but expect substantial deductions from current book value estimates over the next 4-5 years.

2008 Aug 11 07:02 AM

[apppro:]

It amazes me how anyone can still be seeing any merit in Ackman or any of his cronies. For no better reason then his own narcissistic ‘Generation Me’ behavior, did he destroy an entire industry; and has left our credit markets and municipalities in a state of chaos.
History will write that this man was a destructive force for our society, and his actions served no better purpose except then to further his own portfolio.

2008 Aug 11 07:02 AM

[Ishortyou:]

Don't forget to consider the rating agencies Moody's and S&P decision to downgrade them, that was the biggest factor in the finantial crisis in the second quarter 2008. That almost cause a severe collapse, the problem is that they dowgrade them on the bases of 'speculation' and not on actual facts.

2008 Aug 11 08:33 AM

[CT Programmer:]

I'm no fan of Ackman, and I'm also long MBIA. But let's really put the blame where it belongs. Ackman didn't make ABK and MBI start investing in a riskier type of business in order to make a better return. They chose to do so, and just like everyone else wrapped up in all this mortgage mess didn't realize the true risk of those investments. There must have been an entire generation of actuaries that weren't doing their jobs, or caving to pressure to make more money. Did Ackman contribute to the knee-jerk reaction to all this and cause their shares to plummet more than they would have? Yes. But my guess is that without Ackman MBI's share still would have gone below $10, just maybe not all the way down to $4.

2008 Aug 11 10:54 AM

[Ishortyou:]

I agree I think there wouldn't be any strategic gain from sueing Ackman, instead I probably would saving that money in building book value by saving all the cash possible forget about share by back or dividends pay outs, because to be upgraded to triple A status takes more capital into consideration, I probably would also sit down and look under the microscope those triple A rated CDO-ABS-MBS to unwind fraudulent loans for book remediation.

2008 Aug 11 11:46 AM

[william:]

instead of speculating on abk which I am long- take a look see @
awrcf.ob--Asian Infrastructure play including Australia,Thailand and China- copper wire for telco and power industry- current price $3.10
you get rev of $510 Million and net of .35-- book value $10.00 ( does not include large hordes of land and building at current values), cash/sh around $3.75- 13.8 million shares outstanding and Michael Dell's fund owns 20%-- you get a PSR=.08, trailing 12 PE 8.8X, trading 20% below cash value and 70% below stated book-- company been growing by 30% during the past 5 years
all this for $3.10-- management intends to list nasdaq soon according to press release.
THE CHEAPEST STOCK IN THE UNIVERSE! AWCRF.OB
CONCERNING ABK- NOT TRADING VERY POSITIVE- IT COULD TRADE BACK INTO THE LOW $3.00 RANGE--LOTS OF UNCERTAINTY- THIS MARKET IS EXTREMELY SENSITIVE TO ANY RATTLE!

2008 Aug 11 07:58 PM

[Tom Armistead:]

Just a note on adjusted book value: MBIA in their last earnings release is now adding back mark to market losses to the extent they exceed impairments. So the adjusted book value adding back mark to market is 39.63. Over time, and in a best case scenario, the share price should tend back up toward that level.

It is a testament to the strength of these businesses that they could make serious underwriting mistakes and then be subjected to merciless attack by short-sellers and rumour mongers, and when the smoke clears there is still this fabulous amount of value remaining.

Steve, you identify the importance of present value - their contracts obligate them to pay pricipal and interest when due, and they cannot be accelerated against. This is one of the features of the business model that makes it so strong.

I am long both ABK and MBI. I had the good fortune to be able to buy some options on ABK, Jan10 2.50 calls for .50. If this ever goes to zero, which I doubt, I lose .50. If it goes up to the adjusted book value, or beyond if mark to market reverses, I will get paid 30 X my investment.

2008 Aug 11 09:14 PM

[Akhenaten:]

Then again there are alot of investors that do not understand the stocks that they buy!
They listen to the "Talking Heads" on CNBC
Again someone has to sell their stock at a loss to drive a stock Down from $80 to .70 Cents
Tis fear / lack of knowledge in their investment

2008 Aug 11 09:29 PM

[Ishortyou:]

I think "cheap chat talkers of CNBC" are one of the least reliable source of information, it is amazing the way they think they master the knowledge of it, then when you do your own homework you realize they are talking nonsense.

2008 Aug 12 08:16 AM

[James Davis:]

hmmmm, market says 'who cares' to the good news delivered above. Sub 4 again.

2008 Aug 12 04:26 PM

[wobatus:]

James Davis, don't speak too soon. Now $6.

2008 Aug 15 03:14 PM