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.