Sunday, September 9, 2007

The Long and Short of First Marblehead

It's interesting how the various constituent players are gaming this thing. After seeing the stock take a thrashing (off nearly 40% YTD) the "bull's are clearly in retreat, though one prominent well respected former analyst continues to "evangelize" on the merits of the company and stock (For the record, I have no position in the stock, but have recommended shorting since last December at around $50.) The quoting of "Bubba" (reputed to be a PM at a short hedge fund) for not making a convincing bear case (recently) plays right into the hands of the numerous shorts who are salivating at the opportunity to clip another 10% quickly by shorting the next rebound. The volatility in the financial institution sector, and likelihood that the credit squeeze carries on for a while, suggests they will get such a chance. The bullish commentator goes on to suggest the stock (FMD) offers lots of long-term value, and that not being a trader like Bubba, he will prevail once the market comes to its senses. He is undaunted by the risks of the securitization markets, competition, and other things, such as valuation (some 3 x book and high single digit P/E), purported highlights of Bubba's case. ( For the record, he quotes Bubba as saying "the bullish case is not made", as opposed to saying that Bubba thinks that "there is a bearish case at this price", a different matter altogether.) The author is a bit disingenuous to say that the bear case is not being made, especially considering the price action since year-end and his own recommendations even at the highs. (If he or others got in much below the current price prior to late 2006, congrats, but they should have sold. They won't get another chance at 50, not this decade.) My sense is that the bear case was made convincingly (unsustainable 40%-plus ROE's and peak price/book of 7x) and the decline reflects the even more subdued value creating ability of the enterprise that has emerged since mid year. The liquidity crisis was just the trigger. Certainly, the stock no longer carries the once deserved moniker of the most expensive stock in the Financial institution universe. In fact, if you shorted in the high forties (or $50), wouldn't you have covered? Nobody says the thing is worth Zero. But even if you thought it was worth 20 to 25, the stock feels so heavy, you would probably be waiting for technical rallies for entering new shorts, but you would have already proven your original argument (had you made it) about a ridiculously overvalued stock at $50. Period. By continued evangelizing, many new longs are getting all lathered up in the process, given their own ignorance, and the detailed scholarly quality lectures on securitization, residuals, gain on sale margins, eps growth, BBB tranches being provided by the most prominent FMD prophet. It is unlikely that this will prove to be one of "Peter Lynch"s gems, with bumps and bruises, but for the sake of owners, hope that the misunderstanding of the valuation of financials isn't fatal.

6 comments:

James C said...

For someone "with 10 years fundamental experience dissecting income statements and balance sheets" there was absolutely no fundamental analysis supporting your claim that the stock is over-valued. What are your estimates on margins and volumes going forward? What are your estimates on growth going forward? Will BoA walk away after the contract is up? Will the SLM deal go through?

FIG Investor and Trader Intelligence said...

You didn't address anything, and ought to reread prior posts going back to late 2006, especially if you have owned it since then. Maybe you could find different explanation for decline in valuation, though mine is self explanatory and rather elementary, to be frank. I had no beef with consensus than nor now (estimates of $4 and $4.50) for next two fiscal years ending June 2008, 2009). I assume they are pretty close to management's guidance (or misguidance). (If you have higher estimates by all means elaborate, but it probably won't make a material difference in price targets). Most long-term assumptions (especially for company with short history like this one can be tossed in the garbage. There is best, base and worst case scenarios. Currently, market is pricing in base. Cheers

Never-Limp said...

Why do you think book value is a good valuation metric for FMD? They are not a bank and have a much higher ROE than a bank.

Also, management doesn't give guidance. I'm surprised that you didn't know that.

FIG Investor and Trader Intelligence said...

Why wouldn't BV be relevant, as it is for investment banks, and other financial intermediaries? As I indicated in December 2006 post, ignore ROE-price/BV at your own peril. Without getting into a dissertation on the intangible value of intellectual property, it's not worth nearly as much as proponents would suggests. For any business remotely related to banking/finance, its always a risk. When that risks materialize is obviously never a certainty, but at 6 or 7 x BV, it was a cinch.I don't suggest the stock is ridiculously priced at $32/$33, though I think shorts will be coming in hard right here after yesterday's rally.
s rally.

unclelonghair said...

>>> Why wouldn't BV be relevant, as it is for investment banks, and other financial intermediaries? <<<
Book value is not relevant for intermediaries because they don't put any equity in their deals and have no need for financing. Consider HFF, Inc (HF) just to pick one example, they are a "capital intermediary" in the commercial RE market and trade at a price/book of 6, after the stock has fallen by 40%. CBG is in the same industry and has many other lines of business that require capital and they are at a price/book of 4.2. Comparing FMD to thrifts and lenders and the like is comparing apples to oranges. FMD is strictly a service business (though this may change) and thus has very high price/book and ROE figures which are entirely justified by business performance.

FIG Investor and Trader Intelligence said...

you gave two bad examples; both have been under considerable pressure. That's the point, the margin of safety is quite slim in all three. BV is relevant, to the extent, the "intangible" value intellectual capital ceases to be able to generate excess returns, above and beyond the cost of capital. Hence, unless your faithful promoters can do a better job of making a case for sustainable excess ROE's, the probability of a decline in the price/book is a virtual guarantee. (although we are well off the highs of 7xBV). This stock seems to have a cult like following among bulls, even greater than that of the bears that share my conviction.