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FOOL PLATE SPECIAL
An Investment Opinion
by Louis Corrigan
Long-Term Capital Wasn't
Sometimes the wizards of Wall Street turn out to be just little men turning levers behind a curtain, hoping against hope that they're never revealed in their pathetic nakedness. Well, we would turn our eyes out of common decency, but the spectacle surrounding the beleaguered hedge fund Long-Term Capital Management is both fantastic and historic.
Founded in 1994 by famed bond trader and former Salomon Brothers chair John Meriwether and other luminaries, including Robert Merton and Myron Scholes, Nobel laureates in economics, Long-Term had prospered by making huge, leveraged, computerized bets on international bond markets. But after beginning the year with $4.8 billion in capital, Long-Term had just $2.3 billion left by the end of August, when it lost 44% of its capital partly on an ill-fated bet on the direction of European interest rates and partly on losses in emerging markets such as Russia, which imploded. The fund's troubles only got worse this month as the emerging market debt failed to recover and the U.S. treasuries it had shorted as a hedge kept rising. That is, the "spread" it hoped would narrow actually widened. That reportedly left the fund with over $80 billion in positions supported by just $600 million in capital. All attempts to raise more capital from its current investors failed. Meriwether even asked billionaire speculator George Soros for help. No dice.
Long-Term's untenable position could be resolved in only two ways: a liquidation that could force its lenders to declare losses on investments currently underwater while creating financial panic among international bond traders from massive selling that would likely contribute to more insolvencies -- or a bailout. In a historic move, the New York Federal Reserve Bank late yesterday brokered a deal between Meriwether and a consortium of major U.S. financial institutions including Goldman Sachs, Merrill Lynch, Morgan Stanley, J.P. Morgan, Chase Manhattan, and UBS. The deal reportedly calls for a $3.5 billion cash infusion, with 11 firms putting up $300 million each while four others pump in $100 to $125 million. The original Long-Term investors will walk away with just 15% of the fund's equity -- that is, they will lose almost everything. Moreover, the fund's activities will now be overseen by an oversight committee including representatives from these Wall Street powerhouses. The plan should buy the fund more time to unwind its trades and to prevent further destabilization of international markets.
What makes this story so extraordinary is that Meriwether is one of the most respected traders on Wall Street. In Liar's Poker, the best-selling account of Salomon's heyday in the late 1980s, Michael Lewis writes that people at Salomon would talk about Meriwether with awe, calling him the best bond trader on Wall Street, indeed, "the best risk taker I have ever seen." Moreover, Long-Term was mostly employing highly sophisticated quantitative trading strategies that avoided the kinds of directional bets for which George Soros is legendary and instead simply played spreads and inefficiencies in the market, a supposedly no-lose proposition.
Crowning this story of the way markets punish hubris is that it developed on the same day Merrill Lynch Vice Chairman John Steffens got play in the Wall Street Journal for calling do-it-yourself online trading no better than gambling and "a serious threat to Americans' financial lives." As it turns out, Merrill Lynch raised much of Long-Term's initial capital. It seems fitting that a firm behind one of the greatest, most destabilizing financial blowups of the decade would want to lecture individual investors about risk. How Wise.
Children's and branded shoe marketer Stride Rite Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SRR)") else Response.Write("(NYSE: SRR)") end if %> strolled $11/16 higher to $9 3/8 after reporting fiscal Q3 EPS of $0.27 versus $0.17 last year, beating the Street's mean estimate by $0.02. Net sales during the period increased 17% to $168.5 million, with sales of its Keds line of shoes jumping 49%.
Online services conglomerate America Online <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AOL)") else Response.Write("(NYSE: AOL)") end if %> picked up $2 9/16 to $117 13/16 after Donaldson, Lufkin & Jenrette reiterated its "top pick" rating on the stock. Other companies in the Internet world rose as well. Excite <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: XCIT)") else Response.Write("(Nasdaq: XCIT)") end if %> advanced $3 3/4 to $41 1/2, Amazon.com <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AMZN)") else Response.Write("(Nasdaq: AMZN)") end if %> rose $4 9/16 to $109 11/16, and Infoseek <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SEEK)") else Response.Write("(Nasdaq: SEEK)") end if %> climbed $2 to $26 5/16.
British enterprise application software developer and Year 200 problem-solver Micro Focus Group PLC <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MIFGY)") else Response.Write("(Nasdaq: MIFGY)") end if %> gained $3 13/16 to $25 after shareholders approved the company's merger with software configuration management firm Intersolv <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ISLI)") else Response.Write("(Nasdaq: ISLI)") end if %>. The companies are expected to close the deal today.
Audio books direct marketer Audio Book Club <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: KLB)") else Response.Write("(AMEX: KLB)") end if %> gained $3/4 to $9 3/8 after signing an advertising agreement with online discussion forums service Deja News to be the service's exclusive book club.
Metals distributor and processor Inland Steel Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IAD)") else Response.Write("(NYSE: IAD)") end if %> forged a $1 gain to $21 after offering to acquire the 13% stake in metal services firm Ryerson Tull Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RT)") else Response.Write("(NYSE: RT)") end if %> that it does not already own for about $58 million in stock. Separately, Inland authorized the repurchase of up to 2.5 million Inland shares on top of its 2.35 million share buyback plan already in effect.
Auto structures and suspension systems maker Tower Automotive <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TWR)") else Response.Write("(NYSE: TWR)") end if %> drove $1 3/16 higher to $17 9/16 after saying its fiscal Q3 earnings will be about 10% higher than the $0.32 per share expected by the Street, despite a $0.04 per share hit to its earnings in the period owing to this summer's strike at General Motors <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GM)") else Response.Write("(NYSE: GM)") end if %>.
Carbon and graphite electrodes maker UCAR International <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: UCR)") else Response.Write("(NYSE: UCR)") end if %> gained $1 15/16 to $15 7/8 after announcing a global restructuring plan aimed at saving a total of $330 million over the next three years. The company added that it expects to report fiscal 1998 EPS between $2.30 and $2.45 (excluding a $150 million charge in Q3 related to the restructuring), which will be shy of the First Call mean estimate of $2.65.
ChiRex Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CHRX)") else Response.Write("(Nasdaq: CHRX)") end if %> moved up $1 3/4 to $11 1/2 after Legg Mason reiterated its "buy" rating for the provider of outsourced pharmaceutical manufacturing services, with a price target of $30 per share.
Financial services holding company Imperial Credit Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ICII)") else Response.Write("(Nasdaq: ICII)") end if %> gained $3/16 to $7 3/4 after announcing a plan to repurchase up to 10% of its outstanding shares. The company said it has just completed buying back 5% of its stock under a previously announced plan.
The world's largest soft-drink company, Coca-Cola <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KO)") else Response.Write("(NYSE: KO)") end if %>, fell $9/16 to $57 7/16 after calling analysts to organize a "volume and earnings update for the third quarter and the full year" tomorrow morning, signaling that the company likely will guide near-term estimates lower, The New York Times reported. Although many analysts already have cut estimates on Coke's volume and earnings recently based on the relative strength of the U.S. dollar, an earnings warning from the company could mean further downgrades by Wall Street. For more details, see today's Breakfast With the Fool.
Investment bank, brokerage, and Discover card issuer Morgan Stanley Dean Witter <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MWD)") else Response.Write("(NYSE: MWD)") end if %> dropped $3 5/16 to $53 15/16 after beating already reduced earnings forecasts of $1.03 a share with third quarter EPS of $1.05, down from last year's $1.09. Revenues fell 6.5% to $3.841 billion from $4.107 billion. Other big banks also fell after rallying yesterday on Alan Greenspan's comments suggesting a possible interest rate cut. Citicorp <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CCI)") else Response.Write("(NYSE: CCI)") end if %> lost $4 3/16 to $101 5/16, while merger partner Travelers Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TRV)") else Response.Write("(NYSE: TRV)") end if %> gave back $1 13/16 to $41 1/8. Chase Manhattan <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CMB)") else Response.Write("(NYSE: CMB)") end if %> shed $3 1/8 to $47, Merrill Lynch <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MER)") else Response.Write("(NYSE: MER)") end if %> tumbled $3 1/2 to $54 1/2, NationsBank <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NB)") else Response.Write("(NYSE: NB)") end if %> slid $2 11/16 to $56 1/16, BankAmerica <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BAC)") else Response.Write("(NYSE: BAC)") end if %> fell $2 11/16 to $62 9/16, Bankers Trust <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BT)") else Response.Write("(NYSE: BT)") end if %> tanked $4 13/16 to $63 1/4, and American Express <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AXP)") else Response.Write("(NYSE: AXP)") end if %> was trimmed $3 3/8 to $80 1/16.
Investment banking firm Friedman Billings Ramsey Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FBG)") else Response.Write("(NYSE: FBG)") end if %> sank $1, or 15.8%, to $5 5/16 after late yesterday announcing that it anticipates a Q3 loss of $0.70 to $0.75 a share, compared with earnings of $0.26 per share in the same year-earlier period and analysts' expectations of a breakeven quarter. The firm blamed the loss mostly on trading losses.
More bad news from oil-related companies trying to weather the prolonged decline in oil prices. Oilfield equipment and services company Baker Hughes <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BHI)") else Response.Write("(NYSE: BHI)") end if %> slid $2 1/16 to $21 11/16 after warning it expects operating EPS for the quarter ending September 30 before charges to be about half of the analysts' mean estimate of $0.36. The company said results are being hurt by a slowdown in activity as well as by delays caused by storms in the Gulf of Mexico. Meanwhile, oil company Atlantic Richfield <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ARC)") else Response.Write("(NYSE: ARC)") end if %> slipped $3/16 to $71 3/16 after saying it will cut jobs, expenses, and investments to ride out the storm and avoid being acquired by a larger competitor.
Furniture rental and sales retailer Aaron Rents <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RNT)") else Response.Write("(NYSE: RNT)") end if %> lost $1 9/16 to $14 1/2 after warning that although its Q3 revenues will be more than 20% higher than last year, earnings will fall short of analysts' estimates and may be flat from a year ago. The company said that expected synergies from its acquisition of the Blackhawk Convention Services business last December have not been realized.
High-end accessories company Gucci Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GUC)") else Response.Write("(NYSE: GUC)") end if %> went out of fashion this morning, falling $2 1/16 to $37 7/16, after reporting fiscal Q2 EPS of $0.65, down from $0.69 in the same prior-year period though slightly higher than analysts' expectations of $0.63.
Communications and electronic products maker Harris Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HRS)") else Response.Write("(NYSE: HRS)") end if %> shed $3 1/8 to $33 15/16 after announcing it expects EPS from operations will be "slightly below" a year ago and roughly 10% lower than analysts' mean estimate of $0.58 for its fiscal Q1, with the same pattern for results for the full year. The company attributed the shortfall to the downturn in the semiconductor market and general market weakness in Asia, Russia, Eastern Europe, and South America.
Packaging manufacturer and ceramics and other engineered materials company ACX Technologies <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ACX)") else Response.Write("(NYSE: ACX)") end if %> plunged $4 to $13 after announcing that it expects Q3 EPS of $0.28 to $0.33, before restructuring charges, as well as lower-than-expected Q4 EPS due to heavy price competition. Analysts were forecasting Q3 EPS of $0.48 compared with last year's $0.41.
SCI Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SCI)") else Response.Write("(NYSE: SCI)") end if %> dropped $2 11/16 to $27 1/8 after the contract manufacturer of electronics for computer makers warned that fiscal Q1 revenue may be "below analysts' expectations by a single digit percentage," though earnings will approximate current expectations.
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Contributing Writers Yi-Hsin Chang (TMF Puck), a Fool Brian Graney (TMF Panic), Fool Two Alex Schay (TMF Nexus6), Fool, too Dale Wettlaufer (TMF Ralegh), Final Fool
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