A significant amount of discussion surrounding Too Big to Fail ("TBTF") centers around resolution, essentially how to monitor potentially systemic problems and defuse them in the future. Discussions regarding Wall Street compensation have largely fallen by the wayside as many feel that compensation, while obscene and unjustified in many cases, is a sacred cow. After all, in "free markets" companies should not have pay levels dictated to them by the government. Free markets being displaced by crony capitalism over the past decade aside, policy makers should realize that TBTF and compensation are inextricably linked as TBTF is essentially a taxpayer subsidy for TBTF investors and bank employees to pursue high risk activities.

Current legislation proposed by Barney Frank focuses mostly on how to smoothly address the failure of a TBTF institution in the future such that financial and economic dislocations are minimized. Frank's proposal includes the creation of a "council" consisting of the Fed, FDIC, Treasury, and the SEC that would monitor TBTF institutions. The composition of this council is ironic considering the numerous collective failures during the financial crisis, but another problem with this council is that it is likely to increase the problem of regulatory capture.

Equity Markets De-Risking

The mid-point of September 2009 marked the one year anniversary since the fall of Lehman Brothers. Interestingly enough, since that period many stocks that experienced strong performance since March 2009 have started to experience substantial corrections. The market appears to be de-risking as many small and mid-cap stocks have taken major haircuts, while a number of larger capitalization stocks appear to have held steady, if not improved, illustrated by Exhibits I and II.

Did Bill Miller or Legg Mason bribe Barron's for a recent cover story? Or has Barron's assumed investors cannot understand elementary math? Given Miller's atrocious performance in recent years, followed by positive 2009 performance that still has investors that committed capital to Value Trust in 2007 down considerably, one must wonder how Miller could obtain the Barron's cover story on October 12th entitled "It's Miller Time."

In the article, writer Tom Sullivan suggests that investors consider investing in Value Trust given its 38% YTD return, which places it in the top 5% of all large blend mutual funds. According to Sullivan, this performance represents "an amazing about-face from early March, when his fund had lost 72% of its value in a matter of about 18 months." Is this really an amazing about-face? Anyone familiar with Miller's investing approach and fund composition tilt towards financials should not be surprised with his performance in 2009.

In recent months, Pershing Square founder Bill Ackman has been increasing pressure on Target Corp. (TGT or the "Company"), attempting to supplant certain Board members. TGT investors have likely been following the situation very closely, given that shares of TGT have struggled since 2007. But before electing Ackman and his suggested members, investors should take a closer look at what Ackman originally proposed, before blindly electing his slate due to frustration with TGT's share price.

While TGT's Board is ripe for change, the Company is hardly worthy of significant activism. TGT is a great company that happens to compete with some other truly phenomenal companies in terms of operational efficiency. Companies like Wal-Mart Stores (WMT) and Costco (COST) are formidable competitors and critics have recently cited TGT's underperformance relative to WMT and COST as proof that a Board shake-up is warranted. This may be unfair to TGT because since 2004, TGT shares have basically returned the same as WMT.

The past eighteen months were difficult for many investors and fund managers across a variety of strategies. The credit crisis resulted in major market stress that yielded correlations of nearly one across equities such that performance was largely dictated by the net long exposure of investors. Nearly halfway through 2009, investors seem willing to view 2008 as a “six sigma” year and probably have little interest in attempting to learn much from it. While in many cases all investors can do is throw their hands up in exasperation, the past 18 months have provided some interesting lessons to those in value investing circles.

Since 2001, value investing has experienced a surge in popularity. Part of this stemmed from the increased popularity of new, younger fund managers over the past decade. Fund managers like Bill Ackman, who was given a second life with Leucadia’s seed investment in Pershing Square, Mohnish Pabrai, and other value-oriented fund managers achieved rock star status in recent years. The status of many value fund managers was well deserved given their performance, but many of these managers were assumed infallible by the media as well as value investors. Value investing “tradeshows” such as the Value Investing Congress, where attendees fork over several thousand dollars to hear about choice investments held by some heralded managers, and various “value investing newsletters” further proliferated this notion.

In early 2008, Doug Kass of Seabreeze Partners and TheStreet.com issued a sell short thesis on Berkshire Hathaway (BRK.A) which outlined some of his views as to why BRK was an attractive short candidate. Recently, Kass has come out with some updates on his BRK short with some rather sensationalized titles such as, "Is This the End of Warren Buffett?" Titles like that can certainly generate web traffic but don't change the fact that this sell short call - in the context of the current market - is based on a very weak thesis.

I don't own BRK stock because I've never been able to invest in it when it's been at a price that I felt was truly on sale. WEB [Buffett] may also feel the same way because of his general historical aversion to repurchasing BRK stock. From a strictly philosophical reason, I also feel, as a fund manager, I should be able to find better investments than a $140B mega cap company that has holdings in widely held companies like Johnson & Johnson (JNJ) and Coca Cola (KO).

Broad macro pressures have finally caught up to Jarden Corp. ((JAH) or the "Company") in recent months and that combination, along with a considerable debt load, is presenting a rather toxic atmosphere for the Company, its investors, and its lenders in 2009. While various risk aspects of JAH have been covered in previous posts, there are two items that should be considered ahead of its Q4 08 earnings release - JAH's credit rating and the value of its Goodwill and Intangible Assets.

In December 2008, Moody's lowered its rating outlook for the Company, citing JAH's 2009 revenue guidance. What's surprising is that Moody's has not reduced its outlook from stable to negative given the headwinds facing the Company and its difficult leverage position. During JAH's Q3 08 conference call, CEO Martin Franklin stated that he expected that the Company's leverage ratio would decline from 3.6x as of Q3 08 to under 3.5x by year-end 2008. Instead, in December, the Company released a warning stating that its leverage ratio would be roughly 3.7x as of Q4 08.

<< back to The State of Financial Markets and U.S. Dollar in 2009, Part I

While credit conditions are easing, banks are still insolvent and commercial real estate will pose further strains on capital markets in 2009. Although one can’t predict the actions of any government, on the surface commercial real estate does not appear to be as strong a “bailout” candidate as residential real estate and banks. In 2009, commercial REITs, specifically what some believe is the safe apartment sector, could be at risk. Some apartment REITs are located in areas where housing has experienced major corrections. With home prices falling significantly and mortgage rates continuing to decline, home sales could be set to moderate from the severe declines experienced over the past 18-24 months. Simply stated, owning a home in certain previous bubble territories is getting cheaper while some apartment REITs expanded capacity during 2004-2007. These apartment REITs borrowed considerably on the assumption of high rental rates. However, in 2009, with so many homes on the market that are becoming increasingly attractively priced, a supply/demand imbalance in certain markets has arisen where homes, now priced to move, and apartments, are in tight competition. This matters because apartment REITs have considerable debt loads based on the assumption of high rental rates which will come under pressure as vacancies rise due to economic strains and also competition from the glut of homes available in certain markets.

After a disastrous performance by equity markets in 2008, the general consensus is that equity markets could do better in 2009. Performance estimates by some bullish prognosticators range from 10-30% which would be welcome but are nowhere near enough to make up for the losses suffered since October 2007. For broadly diversified long-only investors, it could take many years to reach portfolio values achieved in October 2007. Nonetheless, there are some opportunities to construct some defensive long/short portfolios and also engage in some broader macro themes for individual and institutional investors.

Are US Equity Markets Cheap?

The economic malaise is likely to persist through 2009 and the downturn which started in December 2007 could last for much longer than the majority of economists expect. Nonetheless, in 2009 we might witness specific divergences in the performance of individual equities relative to 2008 that could allow for meaningful returns.

For example, in 2008 correlations across equities increased, meaning that, with the exception of a few companies, irrespective of what one owned portfolio values generally declined. This meant that a large contributor to 2008 performance was the level of short exposure in one’s portfolio. As I’ve told some colleagues, in 2008 one could short anything and look like a genius. This may change in 2009, and investors who can do substantial work at the company level could be positioned to benefit by implementing long/short strategies.

Last week, Jarden Corp. (JAH) issued a press release indicating that its Q4 08 sales would be roughly $1.3B compared to analyst estimates of $1.5B. While sales for Q4 08 will be well below Street estimates, the Company did not reveal any margin information and also indicated that JAH 2009 revenues would be $5B or 8% below Street estimates of $5.4B.

JAH also expects 2009 cash flow less capital expenditures will be $250MM. Moody's Investors Services quickly followed up by issuing a negative outlook on the Company. While it has taken far longer than anticipated, it appears that the Street may slowly be coming around to understanding the risks facing JAH.

I've received a few emails regarding my short position on Jarden Corp. (JAH or the "Company") given the market malaise which has taken all stocks down. Most of the emails, irrespective of whether the person was an investor, a short seller, or just an observer of JAH, expressed curiosity whether I was still short the Company. The short answer is "yes" and given JAH's latest Shareholder Rights/Poison Pill announced on November 20th, I thought it might be a good time to provide an update. The Shareholder Rights plan was adopted because JAH's Board wanted to protect investors from opportunistic investors or buyers given the current share price. I can understand management wanting to seek maximum value for its company but I found the notion of JAH being attractive to any strategic buyer at even the current price laughable, considering JAH's weak balance sheet in the current macro environment and the lack of any real assets other than intangible brand names and goodwill.

EXHIBIT I: JAH Q308 BALANCE SHEET

I had received some emails and phone calls from BioScrip ("BIOS" or the "Company") investors over the past few weeks asking what my investment status with the Company was and I wanted to provide a broader update. I actually sold my position in BIOS prior to Q3 and in fact have shorted BIOS off and on, generally trading the stock with a focus on what I think is growing downside for the Company. Aside from BIOS-specific issues, I have no long interest in the Company because with the market experiencing such a significant sell-off, relative value comes into play and BIOS, at nearly any price, offers little relative value to most companies these days. Notwithstanding the broader market issues, there are a number of items that made it clear that maintaining a long position in BIOS offered little upside and cutting my losses was far more sensible than digging my heels in.

When I first discussed BIOS, some investors reached out to me and were very helpful in terms of suggesting ways of changing the Board to ultimately remove CEO Richard Friedman and his cronies and (preferably) pushing the Company into the hands of an acquirer. It's important to note that many rumors have circulated with respect to BIOS being approached by a variety of strategic buyers as recently as this year, but Friedman, whose main incentive is his compensation rather than shareholder value, has never informed his investors. As a result, any attempt to generate value from BIOS would require the help of a large investor; I had hoped Heartland Funds ("Heartland") would be willing to take a more activist stance with the Company given its long history with BIOS as an investor and what I'd hope would be major disappointment in the Company's performance.

The current market turmoil, while painful, has also produced a number of attractive opportunities. The small cap area in particular has resulted in a number of valuations that one could read about in Ben Graham books but are rarely expected to be seen in a modern, electronic-based "efficient" market. However, when reviewing a number of small caps to invest in, I came across Lifeway Foods Inc. (LWAY or the "Company") and found what appears to be a good short sell candidate. While the stock is close to its 52 week low, I was still baffled by its seemingly absurd valuation and believe it has significant downside risk given the frothy valuation multiples it commands, irrespective of a bull or bear market.

LWAY was founded in 1986 and is a manufacturer of probiotic, cultured, functional dairy and non-dairy health food products. The Company's primary product is kefir, a drinkable fermented dairy beverage similar to yogurt. Kefir contains live microorganisms and nutrients, is highly digestible, and can be considered one of the most favorable dairy products for people suffering from genetically-based lactose intolerance. This could be in part due to its low curd tension, meaning the curd breaks up very easily into smaller particles which aids in the digestion process.

Since BioScrip Inc. ("(BIOS)" or the "Company") released Q2 08 results, I've had the chance to communicate with other investors and it has become apparent that many share my displeasure with management and the Company's current direction. What's been particularly frustrating is that management and the Board have yet to devise any real benchmarks or even long-term guidance on what investors can expect in terms of operating results. Since BIOS has a fixed cost structure, minor changes in business results can have substantial impacts on EPS, making the final result very volatile and thus difficult for the market to get comfortable in approximating a fair value for the Company. 

In addition, given the Company's CEO - Rich Friedman - and his horrific track record in terms of performance and compensation, investors have every right to hold off from making meaningful investments in the Company until Friedman can prove he can consistently generate profits. Given my conversations with other investors, it is becoming increasingly apparent that leaving Friedman in charge is a recipe for disaster and that BIOS could generate far more value if a strategic buyer purchased it. I believe investors are willing to vote their shares if a strategic buyer approaches BIOS with a fair offer. The following is a brief review of where BIOS investors currently are and more importantly, what BIOS could be worth if a strategic buyer purchased the Company.

Priceline.com ("PCLN" or the "Company") reported earnings in early August, exceeding Street estimates and raising guidance for the year.  On the surface, those results would usually lead to a strong rally in the stock, but PCLN shares instead fell by over 10% after earnings.  Even with the stock under $100 and over 30% off its peak, shares in PCLN may still be overvalued given the headwinds currently facing the Company.

Smaller "Beat" Rates: PCLN has benefited from good execution by management and management's ability to outperform not only its own expectations, but Street expectations as well.  However, the Company's Q2 beat was its smallest in six quarters, beating Street estimates by just 9.9%.  With the exception of the Company's Q1 08, the trend in terms of the size of the EPS beat has been declining over the past several quarters.  PCLN has been a classic "beat and raise" story for the past few years, but the level of both the "beat and raise" is decreasing. As PCLN's earnings growth decelerates, PCLN's valuation multiples could experience compression, further pressuring shares.

TABLE I: PCLN ACTUAL VS. CONSENSUS ESTIMATES

When I first started writing about BioScrip Inc. (BIOS) I received some encouragement from a variety of shareholders, including both individual and institutional investors who had been disappointed in management's continued incompetence.  I also attracted the attention of private specialty pharmacy operators and former employees, which further supported the notion that the Company's management team and Board are unfit to run BIOS. 

I was surprised, however, to find a few smaller investors suggest that my comments ended up driving BIOS down even further. Aside from the laughable notion that my comments could move this stock, the main issue is that BIOS has some valuable assets that are being obscured by management's multi-year history of blunders which have eroded any level of management credibility and the Q2 08 conference call further supported this notion.

After yesterday's earnings warning it looks like the Crocs Inc. (CROX) story is headed to an end.  With revised 2008 expectations of revenue undperforming 2007 figures and EPS at breakeven, at $4-$5 per share, CROX is still grossly overvalued.  In addition, there's been very little action by management over the past few months to suggest that insiders have any belief that CROX shares represent a bargain.