(note: this post originally appeared last Thursday on my Yahoo! Finance contributor page.)
Last week, a longstanding short in my fund released one of the grimmest quarterly reports I’ve seen in three decades of managing money. The company’s most important sales metric dropped at a double-digit rate, meaning its near-term revenues are going to be abysmal (after all, today’s sales are tomorrow’s revenues). Its long-term outlook isn’t great either because its most profitable product is fast becoming obsolete. Meanwhile, sales rates for new, less profitable products are modest and the business is hobbled by more than $2 billion in debt, all of which is coming due in less than two years. On the plus side, the company still generates a fair amount of cash, almost $400 million last year. Too bad interest payments to service its monstrous debt load were almost as large.
Declining sales, a sunsetting business model and crushing debt. If that isn’t a recipe for bankruptcy, I don’t know what is. Oh yeah, did I mention that this same company has already filed for Chapter 11 protection twice in the last decade?
I’d love to tell you the name of this business. Hell, I just wrote a book called Dead Companies Walking and this is probably the best example of a company heading for oblivion in the market today. But naming it would almost certainly wind up costing me and my investors a ton of money.
[Note: this post originally appeared on the CFA Institute’s Enterprising Investor blog.]
Recently, Barron’s ran a short item on New York City’s plan to convert more than 6,000 remaining pay phones in the city into “digital kiosks” that emit Wi-Fi signals and contain charging stations for mobile devices. I’m sure most readers had a similar reaction to mine: “Wow, there are still 6,000 pay phones left in New York City?!” But that’s not what made the article interesting — and potentially valuable to novice and professional investors alike.
The two ways to go bankrupt, as Ernest Hemmingway famously wrote, are gradually and then suddenly. The “gradually” phase of the process can take a good long while, sometimes years, but once a business starts to exhibit the two biggest symptoms of impending disaster–falling revenues and mounting debt–the “suddenly” part is all but inevitable. It came for the troubled biotech company Dendreon (ticker: DNDN) on Monday when it filed for Chapter 11 bankruptcy.
The move should have surprised exactly no one, and not just because I predicted it well over a year ago now on Seeking Alpha. Back in September, the company’s own management warned that it was probably going to wipe out its shareholders. But that didn’t stop credulous investors from buying Dendreon’s stock–incredibly, it didn’t dip below a dollar until earlier this month–or dubious stock boosters from feeding their hopes for a miraculous turnaround. Take a look at the headline on a Zack’s.com posting: “Why Earnings Season Could be Great for Dendreon.” The article, which gives DNDN a buy rating, is dated November 10, 2014–the exact same day the company announced that it had filed for bankruptcy.
Astronomers constantly scan the night sky for supernovas so that they can observe and study how stars die. It’s a fascinating process. Right now, a very large corporate supernova has begun and it is just as fascinating–and educational. Unfortunately, I was forced to cover my short position in the dying company because my prime broker now charges me an exorbitant “negative rebate” to short stocks. But I’m still watching from a distance.
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.