When I’m scouting dead-companies-walking, I look for a number of factors. Businesses fail for all sorts of reasons, after all. But there are almost always two main symptoms of a company in terminal condition: falling revenues and mounting debt. These twin problems feed one another and create a kind of corporate death spiral. As revenues drop, debts rise. Making matters worse, creditors begin to demand higher and higher interest rates to service that debt, which means that repaying it eats up more and more of a company’s shrinking revenues. Pretty soon, that company can’t meet its obligations and its only option is to declare bankruptcy.
I usually find comparisons between government and business strained. But with a government shutdown looming by midnight tonight and the very real possibility that the U.S. Treasury will renege on its credit obligations becoming more likely every day, Washington D.C. is starting to look like the dysfunctional boardroom of a business fast on its way to insolvency.
In 1984, when I was a fresh MBA working at the largest bank in Texas, I was browsing through the now-defunct magazine Investment Decisions and I came across an article titled, “Do Stock Splits Help Stock Prices?” It was written by a man I had never heard of. His name was Warren Buffett.
I generally find the public’s fascination with would-be financial messiahs puzzling, even pathetic. All my life, I’ve watched one market “guru” after another tout some secret formula for beating the street, only to fade into obscurity. But “The Wizard of Omaha” is an exception. He definitely deserves the fame he’s acquired. He’s delivered more helpful investment advice than any other living American. (Vanguard founder John Bogle is a close second in that regard.) Believe it or not, I have kept Buffett’s Investment Decisions article with me for the last 30 years. I’m looking at it right now as I type, and Buffett’s insights are as apt today as they were back in the days of Swatch watches and New Coke.
Last week, I posted an article on Seeking Alpha on the troubled biotech firm Dendreon (DNDN). Eighteen months ago, I shorted over 200,000 shares of the company. As I said in the article, even though the stock has lost its half its value, I haven’t covered a single share, and I doubt I ever will. Why? Because it’s a classic example of what I call a dead-company-walking. In the near future, probably less than two years, I believe it is destined for one fatal outcome: bankruptcy.
This prediction, and the fact that I have sold the stock short, generated a fair amount of negative reactions to the piece. One commenter declared that all short sellers should be “iviscerated” (sic). Yikes! Others respondents were less colorful, but no less angry. They blamed short sellers like me for bringing down what they believe is a good company with a beneficial cancer drug. But blaming shorts like me for Dendreon’s demise shows a fundamental misunderstanding of corporate capital structures and how bankruptcy works.