Top Gun FP Client Note: Let The Bubble Blow
NOTE: Every week I write a Client Note for my clients. For a limited time, I am allowing non-clients to sign up and receive the Client Note. You can sign up at the top right hand corner of the website. Here is this week’s.
Let the bubble blow.
That’s the signal the Federal Reserve gave to commodities markets and the stock market Wednesday after keeping interest rates unchanged at historic lows and making no noise about when its policy of easy money will end.
The most important event last week was the FOMC (Federal Open Market Committee) decision on interest rates. Everybody knew that there would be no change to policy but there was a lot of attention focused on the statement. Would the Fed start to suggest an exit strategy?
Well, Bernanke and Company revealed their hand by not tinkering with the statement at all. It was the most dovish possible statement given the current state of financial markets, recent strong economic reports, commodity prices including oil and gold, and the state of the dollar. We can continue to expect “exceptionally low levels of the federal funds rate for an extended period of time” they told us.
So the party continues….for now.
There were three other events of note last week that I want to mention.
(1) On Tuesday, Warren Buffett made a deal to acquire the remaining shares of railroad operator Burlington Northern Santa Fe (BNI) that he didn’t already own for $100 a share. That works out to more than $26 billion plus the assumption of more than $10 billion in debt. It was a huge premium to Monday’s closing price and makes a significant difference in the overall structure of Berkshire Hathaway.
The price was not cheap and Buffett said that it was a long term wager on the economic future of the United States. More likely in my opinion, however, was that Buffett had an eye on his succession plan in making this deal.
It puts to work a lot of available free cash into a straightforward business with great management that will essentially run itself. At 79 years old, this is of no small concern to Buffett and Berkshire shareholders. For more see “Complex Motives In Buffett’s Burlington Northern Purchase”
, Top Gun FP, November 5.
(2) Also on Tuesday, the IMF (International Monetary Fund) announced that India’s central bank purchased 200 metric tons of gold from it during daily sales at market prices from October 19-30. The average price paid was $1045/ounce and the purchase represents 8% of global annual mine production.
This $7+ billion purchase says a lot about how many big players are changing their thinking about the dollar, paper currencies and gold. The move in gold is still only in its middle phase in my opinion and has much further to run over the next few years. The New York Times
ran an interesting article on gold on Sunday on the front page of its business section: “Inside The Global Gold Frenzy”
, The New York Times
, November 8, BU1.
(3) Third, on Friday the BLS (Bureau of Labor Statistics) reported an increase in the unemployment rate to 10.2%. Markets didn’t have a strong reaction to the news but the crossing of the 10% threshold is significant psychologically.
Lastly, I want to say something about Top Gun holding Apollo Group (APOL), the owner of The University of Phoenix. We bought Apollo at an average price around $63 starting in early April and it had been a solid performer for us until two weeks ago (Tuesday October 27) when it reported fiscal year 4th quarter earnings. Over the 6 months through October 27, we were up more than 15% on our position, one of our few unhedged long stock holdings, allowing us to participate, albeit in a limited way, in the stock rally.
However, the bottom fell out when they reported fiscal year 4th quarter earnings on October 27 after the market closed. The numbers were phenomenal with 22% enrollment growth, 29% revenue growth and 37% net income growth. The problem was the announcement of the commencement of an SEC inquiry into their revenue recognition policies. Not much is known about the inquiry but investors panicked in the wake of it, dumping 24.2 million shares the next day, about 1/6 of all outstanding shares, sending the stock down 17.7%.
To make matters worse, Barron’s ran a negative front page article on Apollo and other private college operators this weekend. The cover read “College Sinkholes”. In the article, Bill Alpert shredded the private college operators, pointing to high dropout rates, low graduation rates, massive dependence on government education loans and high default rates on those loans. He also questioned the quality of the education provided by these schools and how good of an economic investment they are for students. Finally, he mentioned that an Education Department panel spent last week discussing regulation of the private college operators.
Frankly, the article was powerful and persuasive and got me thinking. The thing that most concerns me about Apollo is its dependence on government loans. According to the article, almost 90% of Apollo’s revenues come from federal government loans and programs – approaching the legal limit. According to Apollo’s most recent 10-K, when a student withdraws, Title IV rules determine if they are required to return a portion of the funds to lenders. If they are, they can still collect these debts from students but the collection rates are very low.
Bad debt expense for fiscal 2009 was 3.8% of revenues, about $151 million. They have marked down $380 million in students accounts receivable they are owed to $270 million (29%) because of concerns about being able to collect on it.
Should the government clamp down on the private college operators, requiring them to refund a lot of government loans, this could be a potentially big problem for Apollo and the rest of the operators in the space. This is a big concern for me and I will be giving it more thought and attention going forward.
For now, we are somewhat protected by extraordinarily low valuations. Apollo, while growing enrollments, revenues and net income at a 20%+ clip is only trading at 10 times current fiscal year’s earnings estimates.
Weekly Returns (11/2-11/6)
DJ Total: +3.26%
Top Gun: +0.98%
YTD Returns (through 11/6)
DJ Total: +20.67%
Top Gun: +7.01%
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