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By Porter Stansberry | 13 December 2008
As anyone who has read my monthly advisory (or this DailyWealth issue) knows, I believe the current financial mess will last much longer than anyone thinks. That's why I believe it's going to be an extraordinarily profitable time for people who are on the right side of several huge trends. One of the biggest trends you need to be positioned for is the collapse of poorly collateralized and highly indebted assets.
There are several obvious and large categories of these kinds of assets. The first is highly leveraged real estate investment trusts (REITs). These corporate structures are truly designed to fail. In order to qualify for their tax benefits (they aren't taxed at the corporate level), REITs must pay out 90% of their earnings.
Thus, to grow, they must either borrow heavily or sell additional equity. Selling equity isn't popular. It "dilutes" current shareholders. So many of these firms end up piling on debt.
If they happened to have made any large acquisitions in the last two years, they're cooked. They can't extend their debt maturities because they overpaid for the assets, which are no longer good collateral. And they can't repay the loans because they don't keep much cash.
Another sector chronically short of capital is airlines. Airlines are, generally speaking, perfectly hedged. They lose money in every market. When times are good, fuel costs kill them. When times are bad, they get killed because of empty seats. Meanwhile, the only way to make any money in such a capital-intensive business is to use lots of debt financing.
When I went looking for heavily indebted companies that can barely afford their debt service, I found a collection of commercial property firms, airlines, and casinos. A few of the highlights are in the table below. You'll find the amount of income these companies made from their operations in 2007 versus their interest costs, along with how much debt they owe in excess of their equity.
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Take mall operator Macerich, for example. The stock is still worth $1 billion, even though the company has outstanding debts four times larger than the equity on its balance sheet and it spent 98% of what it earned in 2007 on interest. Imagine if you owed debts four times greater than your net worth and 98% of everything you earned had to be paid in interest on your mortgage. What kind of bank would lend you any more money?
This Is One Of The Great Buying Opportunities Of The Last 30 Years
I'm confident all of these companies will either go bankrupt or suffer an equivalent massive dilution in order to restructure their balance sheets. I don't think debt financing will be available in the next decade for firms with this much leverage. The debt-centric business model is, quite simply, dead.
Even though I'm sure all of these companies will see their shareholders wiped out, when it comes to shorting stocks, I prefer to have a huge margin of safety. I only want to short companies whose balance sheets and business models are so hopelessly bad that nothing, not even a Christmas miracle, could possibly save them. Why short companies with a 95% chance of going bust when you can short companies 100% certain to go bust?
One idea I encourage you investigate is the pending collapse of deeply indebted homebuilding stocks. If you look at Pulte, Centex, KB Home, D.R. Horton, and Toll Brothers, they all owe around $3 billion. They are unlikely to repay these loans. Already roughly one in 10 mortgage holders is in default. This number will continue to rise as unemployment grows and as more adjustable-rate mortgages reset.
Even if this mortgage crisis is somehow resolved, demand for housing is likely to be extremely depressed for a long time as people will be reluctant to lend or borrow large amounts. It's hard to believe there will be any profitable way to build new homes for at least the next two or three years— and perhaps longer. That means bankruptcy for some of the country's biggest homebuilders.
M O R E. . .
Normxxx
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