AMBAC Just Postponing The Inevitable

Ambac Will Cut Dividend, Raise $1 Billion in Capital

Ambac Financial Group Inc. replaced its chief executive officer, slashed the dividend 67 percent and will raise more than $1 billion to preserve its AAA credit rating after announcing the biggest-ever writedowns by a bond insurer.

Ambac, the second-largest insurer of municipal and structured finance debt, fell the most ever on the New York Stock Exchange, extending a 76 percent decline from the past 12 months. Ambac will report a loss after reducing the value of securities it guarantees by $3.5 billion, according to a statement today.

More Capital?

Ambac, which put its AAA stamp on $556 billion of securities, probably will need more capital because the quality of the debt it guarantees will drop, Tavakoli said. Standard & Poor's today said it plans to re-examine the bond insurer ratings after increasing its assumptions for losses on subprime mortgages.

Until 2007, insuring debt allowed Ambac to increase earnings and dividends every year for the past decade. Net income, which rose 17 percent in 2006 to $875.9 million, probably fell in 2007.

Ambac cut its quarterly dividend to 7 cents from 21 cents, three weeks after stating in a regulatory filing that the payout will remain unchanged. The company will report a fourth-quarter loss of $32.83 a share when it releases earnings Jan. 22. The loss equates to more than $3 billion based on the 101 million shares outstanding.

3 weeks ago the dividend was safe now it's been slashed 67%. Doesn't exactly inspire confidence. This could potentially be the last dividend this company pays.

'A Down Payment'?

Ambac's writedowns, which exceeded those announced last week by MBIA, failed to convince analysts that the worst is over.

"It's one thing to have a plan and another to have a plan that is credible and will be a long-term fix,'' said Donald Light, an analyst with Boston-based consulting firm Celent. "Is this just a down payment in what's going to be a series of payments of uncertain length?''

Yes Donald, it's not going to be nearly enough capital in the long term. Although the $1 billion equity raising will be enough to keep their AAA rating from Fitch, the ratings agencies keep shifting the goal posts.

S&P Will Review Bond Insurers With New Assumptions

Standard & Poor's will start a new examination of bond insurers, one month after affirming the companies' AAA ratings, because losses on subprime mortgages will worse than the firm anticipated.

The ratings company will examine whether insurers including MBIA Inc. and Ambac Financial Group Inc. have enough capital to withstand reductions in the ratings of the mortgage-backed securities they guarantee. The credit test will be completed within a week, said Mimi Barker, a spokeswoman in New York. "The rating agencies have lost as much credibility as the bond insurers,'' said Richard Larkin, a municipal bond analyst with JB Hanauer & Co. in Parsippany, New Jersey. "Every time you turn around they're changing their minds about what's going to happen in the subprime mortgage market.''

Mr Larkin is dead right, as mentioned here numerous times the ratings agencies have been hopelessly behind the curve. Getting back to the first point, is $1 billion really going to fix AMBAC's problems? Not according Bill Ackman who has been shorting the stock for months and has recently decided to short even more shares of Ambac.

The interview below is well worth the watch, Ackman believes AMBAC could need to raise as much as $10 billion or more just to stay afloat.

This company is going the way of Countrywide, either being bought out for a fraction of book value or filing for chapter 11. At least Countrywide had a huge branch network of value, I'm not sure what AMBAC has to offer potential investors.

As expected Retail Sales were weak in December. Also November and October were revised down slightly. From the Census Bureau:

ADVANCE MONTHLY SALES FOR RETAIL TRADE AND FOOD SERVICES

DECEMBER 2007

The U.S. Census Bureau announced today that advance estimates of U.S. retail and food services sales for December, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $382.9 billion, a decrease of 0.4 percent (±0.7%) from the previous month, but 4.1 percent (±0.7%) above December 2006. Total sales for the 12 months of 2007 were up 4.2 percent (±0.4%) from 2006. Total sales for the October through December 2007 period were up 4.9 percent (±0.5%) from the same period a year ago. The October to November 2007 percent change was revised from +1.2 percent (±0.7%) to +1.0 percent (±0.2%).

Retail trade sales were down 0.4 percent (±0.7%) from November 2007, but were 4.3 percent (±0.8%) above last year. Gasoline station sales were up 18.5 percent (±2.8%) from December 2006 and sales of nonstore retailers were up 12.1 percent (±1.8%) from last December.

This is not total capitulation but it does show softness and combined with rising delinquencies among all classes of consumer credit, it looks as though the resilient US consumer is starting to act more cautiously.

And Now For The Expected

As expected Citigroup (C) produced some horrible numbers for the fourth quarter, slashed their dividend and announced much needed capital injections. From Bloomberg:

Citigroup Reports Record Loss on $18 Billion Subprime

Citigroup Inc. posted the biggest loss in the U.S. bank's 196-year history as surging defaults on home loans forced it to write down the value of subprime-mortgage investments by $18 billion.

The fourth-quarter net loss of $9.83 billion, or $1.99 a share, compared with a profit of $5.1 billion, or $1.03, a year earlier, the biggest U.S. bank said today in a statement. New York-based Citigroup also cut its dividend by 41 percent and said it will receive $14.5 billion from outside investors to shore up depleted capital.

``We are taking comprehensive action to position Citi for the future with the capital strength that will allow us to refocus on earnings and earnings growth,'' said Chief Executive Officer Vikram Pandit, who was installed in December after Charles Prince stepped down amid mounting subprime losses.

Citigroup racked up record losses as it misjudged the depth of the mortgage crisis. The writedown for subprime home loans and related securities was almost double what the company expected as recently as November. Citigroup's markdown is the biggest so far, exceeding the $14 billion reported by Zurich-based UBS AG, Europe's biggest bank...

...Citigroup, founded in 1812 as the City Bank of New York, cut the quarterly dividend to 32 cents a share from 54 cents. The reduction, the first since the merger of Citicorp and Travelers Group Inc. in 1998, will help save the company about $4.4 billion on an annual basis. The company said as recently as November that it had no plans to lower the payout to shareholders.

Not reported in the above story was that some of the writedowns were related to the cutting of 4,200 jobs. The capital injection dilutes existing shareholders by approximately 11%. However the name of the game now is one of survival and institutions like Citi and Merrill Lynch will take capital from whoever is willing to invest it.

Speaking of Merrill Lynch (MER), which is expected to report results on Thursday, they announced today that they too are in the process of substantially diluting their existing shareholders and impairing their earnings ability just to stay afloat. Also from Bloomberg:

Merrill Lynch Gets $6.6 Billion From Kuwait, Mizuho

Merrill Lynch & Co., the U.S. bank battered by subprime mortgages losses, raised $6.6 billion by selling preferred shares to a group including the Kuwaiti Investment Authority and Japan's Mizuho Financial Group Inc.

The group also includes the Korean Investment Corp. and clients of U.S. money managers TPG-Axon Capital and T. Rowe Price Associates Inc., Merrill said in a statement today. The mandatory convertible securities carry a 9 percent annual dividend and a 17 percent conversion premium. The investors won't have a say in how Merrill is run, the bank said.

Merrill is raising money after $8.4 billion of writedowns on U.S. mortgage investments led to the biggest loss in its 93- year history in the third quarter. Today's investment comes a month after the New York-based firm raised $6.2 billion from Singapore's Temasek Holdings Pte and Davis Selected Advisors LP.

"We look forward to our relationship with Kuwait Investment Authority providing Merrill Lynch with additional opportunities to grow its presence there," Merrill Chief Executive Officer John Thain said in today's statement. "Because of their extensive corporate client base in Japan and their deep network in China, the Pacific Rim and globally, we expect future collaboration with Mizuho to be very productive."

Yeah, nice attempt to put a positive spin on a dire situation Johnny boy. You've just diluted your existing shareholders by 16% and added almost $600m a year in preference dividend payments to your cost line.

All in all, nothing surprising in either of these reports. Some may argue that Citi's writedowns were less than expected however at the end of the day whether it was $18 billion or $24 billion it's a terrible number and underscores the extent of the problems in the financial sector.

IBM Produces The Unexpected

A couple of days ago I talked expecting the unexpected, both positive and negative. Yesterday IBM came out with the positive, from marketwatch.com:

IBM expects profit to easily top forecasts

International Business Machines Corp. delivered a surprise Monday, saying fourth-quarter earnings for the information-technology giant will easily exceed Wall Street's estimates and touching off a buying spree in Big Blue shares and across the tech sector.

...the company (IBM) said it expects to earn $2.80 a share from continuing operations, up from $2.26 a share in the year-ago fourth quarter. Revenue will grow 10% to $28.9 billion, the Armonk, N.Y.-based company said.

Analysts polled by Thomson Financial have, on average, been expecting the Dow Jones Industrial Average component to earn $2.60 a share on revenue of $27.82 billion.

"The broad scope of IBM's global business -- led by strong operational performance in Asia, Europe and emerging countries -- drove these outstanding results," said Samuel Palmisano, IBM's chief executive, in a statement.

IBM said it would release more details on Thursday, when the company plans to formally announce fourth-quarter results.

Analysts, however, sounded a more cautious note, crediting IBM with a strong performance but urging caution in terms of drawing more general conclusions from the results.

"The million-dollar debate remains [whether] 2008 tech trends weakening, and if so by how much," said Louis Miscioscia of Cowen & Co.

"While it's impressive that IBM's quarter did hit and overachieve our and the Street's estimates, we maintain our neutral rating at this time, given the uncertainties for 2008 with respect to tech spending," he wrote clients.

The details of IBM's 4Q07 report on Thursday will be interesting, particularly with respect to how much the weak dollar helped earnings. On the negative side but not totally unexpected Sears pre-announced a larger than expected decline in 4Q07 earnings. From marketwatch.com

Sears Holdings sees big profit shortfall

Sears Holdings Corp. shares fell 6% in midday trading Monday after the retailer warned that fourth-quarter earnings per share may fall as much as 51% from last year's levels.

Sears Holdings (SHLD) warned it's expecting earnings to fall between $2.59 and $3.48 a share for the three months ending Feb. 2, compared with last year's $5.33 a share.

Analysts polled by Thomson Financial have been expecting fourth-quarter earnings of $4.43 a share, on average.

The stock fell $6.42 to $89.75, eclipsing its earlier 52-week low of $90.80 a share. It's also the first time since early 2005 that the stock has fallen below $90. Downgrades came from Credit Suisse and Goldman Sachs, who cut the stock to sell.

The decline comes after a drop in holiday-season sales for both the company's Sears and Kmart chains. For the nine-week period ended Jan. 5, Sears' domestic same-store sales fell by 2.8% and Kmart's same-store sales dropped by 4.2%.

"Kmart has been crushed by Wal-Mart," said Craig Johnson, president of consulting firm Customer Growth Partners. "It's not a well-managed retailer...

..."We believe that comparable-store sales results reflect increased competition and the negative impact of unfavorable economic conditions, such as a weak housing market and consumer credit concerns," Sears said.

The Sears news was awful but IBM won the day as the market was desperately seeking a catalyst to rally from oversold conditions. To finish this post off it is only fitting to take a look at the effect the unexpected had on one analysts view of Sears, from the same marketwatch story;

Gary Balter, analyst at Credit Suisse, said his previous buy recommendation on Sears was based on the company's free cash flow and asset value.

Now, "over the past few months, we believe the largest piece of that value, real estate, has declined materially, with other pieces including brand value also losing a substantial part of their value in this market," Balter wrote in a note to clients.

He cut his stock price-target to $70, from $150.

This is embarrassing, I hope the dealing desk gives this analyst heaps for what is just a horribly wrong and behind the curve call. Hopefully he didn't convince anyone to buy Sears in recent months.

PWK Gives Green Light For Project Runway

Pipe Networks (PWK) announced today that they have received sufficient revenue generating contracts to proceed with Project Runway. Project Runway is of course PWK's attempt to break up the 'gang of fours' stranglehold on Australian internet capacity by constructing a 6,900 km undersea cable system linking Sydney, to the communications hub of Guam with a spur connecting Madang, Papua New Guinea.

The project is scheduled to be completed by 2Q09 and the company expects to achieve positive cash recovery of the investment within 3 - 5 years. That means the company expects to generate more than $200m in approximately 4 years from the project.

Some back of the envelope calculations suggest that the company could be generating about $100m in revenue by FY10, and given their current NPAT margin of approximately 20%, NPAT of about $20m in 3 years time. That means the company could be generating more than 4 times the NPAT of FY07 by FY10. If that is the case the share price will more than look after itself.

Despite the $200m price tag of the project the company said that they do not expect it to impact previously released guidance of $7.0 - $7.4m NPAT for FY08 and in excess of $10m for FY09. Also they expect to keep their dividend policy the same as previously announced.

Another positive is the fact that the company does not see the need to raise additional capital at this time. However they will seek to extend their existing debt facility of more than $20m. This company is truly on an exciting growth path into the future, the biggest challenge going forward will be their ability to execute the project on time and within budget.

Attention on US earnings

Fourth quarter earnings season kicks into full swing in the US this week. The latest estimates from Standard and Poors suggest 4Q08 operating earnings will show a decline of about -8.2%. Companies of interest include Citigroup (C), Merrill Lynch (MER), J.P. Morgan Chase (JPM), Washington Mutual (WM), PNC Financial (PNC), Wells Fargo Co. (WFC), General Electric (GE), IBM (IBM) and Intel (INTC).

The market is fully expecting a poor earnings season, particularly from financials. Huge multi-billion dollar writedowns from the likes of Citi and Merrill will also come as no surprise.

Of more interest will be company forecasts for 2008. Especially companies in sectors that have been largely immune from the problems in housing, financials and retail. The market was spooked last week by AT&T's admission about a softening consumer. Unexpected comments both positive and negative have the potential to move the markets which are already teetering on a knife edge.

I have been saying for many months that analysts estimates are too high and they have started to come down in recent months. If 4Q07 earnings come in as expected FY07 earnings will actually be slightly negative. Looking out, 1Q08 and 2Q08 estimates have come in slightly from before Christmas to +4.4% and +4.2% respectively. That's largely because their comps (comparable periods from the previous year) are pre credit market turmoil.



When you get to 3Q08 the comps become much easier because 3Q07 was when earnings fell off a cliff. What that tells you is that analysts expect things to get back to normal. This is what gives me more confidence in my recession call. Company analysts, just like economists, are behind the curve in their expectations. Major segments of the mortgage and securitzation markets have just gone away and with them, a lot of profits for financial institutions.

Forget about the huge writedowns from Merrill and Citi and focus on the health of their remaining businesses. Also watch the bad debt provisions for the likes of WM who have already signaled massive increases. This will effectively wipe out their profits for the year.

But as alluded to above the biggest surprises will be the ones that are the least expected. In this increasingly uncertain environment you should be expecting the unexpected (if that's possible). Note that the unexpected does not have to be all negative, plenty of companies will beat forecasts and raise expectations, however you should also be prepared for plenty of negative surprises.

Dennis Kneale is a complete moron

For anyone who regularly watches CNBC, the title of this post will come as no surprise. Dennis Kneal is consistently out of his depth on just about every issue with respect to the economy and the stockmarket. This is evident in his complete lack of knowledge on the aforementioned topics and the grade school platitudes he parrots in just about every interview.

However, today he really out did himself, claiming that investors shouldn't second guess corporate CEO decisions and cited former Merrill Lynch CEO Stan O'Neal as supporting his claims. How the irony of claiming that citing a CEO, that presided over one of the worst blunders in recent corporate history to bolster his argument escapes him, is beyond me. Click on the image below to watch Kneale make a fool of himself.